Should Consumers Use Secured Loans to Pay off Debt?

Michelle Tuvey Michelle Tuvey | Loan Underwriter

There is a lot of misinformation out there regarding personal debt management. For example, it is often assumed that taking out loans to pay off debt is a bad idea because you are just replacing one debt with another. However, such an assumption represents an overly simplistic understanding of how debt management works. It turns out that taking on a new loan to pay off an existing one can be a very wise move.

A recent survey discussed by AOL contributor and veteran financial journalist Sarah Coles suggests that one-third of adults believe all debt is bad. That may explain why people are suspicious of using loans to pay off debt. Nevertheless, as Coles explained, debt can be a good thing. Lenders like to see consumers borrowing and repaying in modest amounts because it demonstrates they can be trusted with credit. Without a track record of borrowing and repaying, a consumer may have a tough time convincing a creditor that he/she is a good risk.

In light of the fact that not all debt is bad, it is also true that taking out a loan to pay off other debts is not always bad. In many cases, doing so is very good. Most people who choose this option utilise either a debt consolidation loan or a secured home loan. Both are essentially the same, with only minor differences in terms and rates.

How It's Done Successfully

The principal of the debt consolidation or secured loan is very simple: the consumer borrows money based on the amount of equity in his or her home. That home is then used as collateral to guarantee the loan will be repaid. The key to making it work for debt repayment is to find a loan with a lower interest rate than the debt you are trying to pay off.

For example, let us assume the consumer has a combined £10,000 in credit card debt at 10%. Taking out a debt consolidation or secured loan for the same amount, at 7% let's say, saves the consumer money in two ways. First, the lower interest rate obviously reduces the total amount of interest paid over the life of the loan. Second, it keeps the consumer on track to pay off the loan without adding to it. This is important when you consider how many people commit themselves to paying off their credit cards only to continue charging as fast as they pay.

Important Things to Know

The survey discussed by Coles also showed that a surprising 42% of consumers believe that ignoring a debt long enough will cause a creditor to simply give up and forgive the debt. That is not true at all. Therefore, if you are swimming in high-interest debt that it unsecured, a debt consolidation or secured loan may be the best way to get it paid off and improve your credit rating at the same time.

You should also know that loan terms vary between lenders. You should make every effort to secure a loan that can be paid off quickly enough to actually save money. Only accept a long-term loan if lower monthly payments are necessary to maintain your day-to-day budget.

One last thing: interest rates on secured and debt consolidation loans tend to be variable rather than fixed. The longer it takes you to repay your loan, the greater the chances you will be subject to a higher interest rate.

You can use secured loans to pay off high-interest debt and save money. Doing so makes good financial sense under the right circumstances.

Sources:

AOL Money ?? http://money.aol.co.uk/2015/08/11/once-you-declare-yourself-bankrupt-you-re-bankrupt-for-life/

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