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Should You Consolidate Debt with an Unsecured Loan?
Debt consolidation provides a means for rolling multiple debts with high interest, such as credit cards, into a single payment. When done correctly, it can be a good way to reduce your total debt and help you pay it off quicker.
What is an Unsecured Loan?
An unsecured loan, sometimes called a personal loan, or a signature loan is one that is issued based on the borrower’s credit score rather than being tied to specific collateral, such as a property.
Typically, a borrower must have a very healthy credit score to be eligible for an unsecured loan. This gives the lender confidence that the borrower will be able to pay back the loan within a reasonable time.
How Unsecured Loans Work
Unlike a secured loan, such as a car loan, for which a borrower must qualify by having a form of asset to stand as collateral for the loan, an unsecured loan requires no collateral.
Because unsecured loans are riskier for lenders, interest rates on them are typically higher than on secured loans. They will often also require a higher credit rating to qualify. In some circumstances, where an applicant does not meet the required credit score, the lender may allow for a cosigner. In this case, the cosigner pledges to take over and repay the loan, in the case that the borrower defaults.
Different Types of Unsecured Loans
Generally, there are three different types of unsecured loans. These include:
- Term loans: With this type of unsecured loan, the borrower must pay regular equal installments until the loan is paid off in full within a pre-agreed loan term.
- Revolving loans: With this type of unsecured loan, the borrower is given a credit limit that can be used, paid back, and then used again.
- Consolidation loans: This is a type of unsecured loan that is used to pay off multiple debts such as credit cards.
Should you Use Unsecured Loans to Consolidate Debt?
Consolidating debt with an unsecured loan is a great idea for some borrowers, and not an ideal option for others. Here are a few of the pros and cons to help you decide whether this type of loan is best for your situation.
The Pros of Consolidation with an Unsecured Loan
On the good side, a borrower can benefit from an unsecured loan because:
- It can offer a lower interest rate than several credit card interest rates combined.
- It offers one convenient monthly payment, rather than having to pay multiple lenders each month.
- A borrower can use an unsecured loan to consolidate several different kinds of personal debt.
- A borrower may be able to lock in a low-interest rate.
- There will be a specific timeline to make repayments, after which time the borrower becomes debt-free.
- Consolidating debt could help a borrower to improve their personal credit score.
The Cons of Consolidation with an Unsecured Loan
- There’s no guarantee that a personal loan will offer a lower interest rate, it could, in some cases, be higher.
- The borrower could end up being charged a higher rate of interest than their current multiple debts combined.
- In some cases, lenders charge a fee for a borrower to take out an unsecured loan.
- A borrower who frees up credit card debt with a consolidation loan may begin to use their credit line again and risk getting into even deeper debt.
When is a Personal Loan a Good Idea for Debt Consolidation?
Borrowers who are considering taking out a personal loan to consolidate debt repayments should do so if they are being offered a lower annual interest rate and the loan offers a path to pay off debts faster. The interest rate and repayment amount should also be fixed at the start so the lender can’t increase them down the line.
When isn’t a Personal Loan a Good Idea for Debt Consolidation?
Borrowers should not consider taking a personal loan from a lender who charges fees to apply for or take out the loan. This type of lender is a predatory lender and should be avoided at all costs.
Borrowers should also be wary of payday loans. These are loans that require no credit check, but come with extremely high-interest rates and often have hidden fees. This is another form of predatory lending. With this type of loan, the rates and fees are so high that repayment can be difficult — so the predatory lender will then encourage the borrower to roll the loan over or to take out another loan to pay back the initial one. In this way, borrowers easily fall into an endless cycle of debt.
How to Apply for an Unsecured Loan
There are several ways a borrower may apply for an unsecured loan including:
- Banks: A borrower who has an existing relationship with a bank may be eligible to apply for a personal loan through them. Not all banks offer unsecured loans, but ones that do may offer a lower interest rate for a member in good standing. However, banks will only lend money to applicants with very strong credit scores.
- Credit Unions: Because credit unions are non-profit organizations, they often offer better interest rates than banks. However, they will also only lend money to applicants with a good credit score.
- Online lenders: Typically, an online lender will require a borrower to pre-qualify by submitting details of income and will also perform a soft credit check.
There is a Safer, Easier Option
For people who have poor credit or a score that is below average, consolidating debt with an unsecured loan may seem impossible. For those looking to consolidate small-dollar debt, TrueConnect may be able to help. This is a great service that eligible employers can provide for their employees at absolutely no cost to the company.
TrueConnect offers an easy application process that does not require a traditional credit check. The process can be completed in three simple steps:
- Employees can fill out a simple loan application form online, and will get their loan approval status right away.
- Borrowers can receive their loan directly into their account as soon as the next day.
- Repayments are easy. They are made with small automatic monthly deductions from payroll throughout the year.
There are also additional benefits to a TrueConnect personal loan. These include:
- A fixed, affordable interest rate for all borrowers
- No credit check is required
- Six free financial counseling sessions for all borrowers
TrueConnect loans stand out amongst alternative lending options because we offer a safe alternative to predatory lenders, so you can rest assured that your employees can have access to cash when they need it, at no cost to you. What’s more, our free financial counseling sessions can help employees manage their personal finances more efficiently.
Find out more about the benefits of offering your employees TrueConnect loans by checking out our Financial Webinar today. You’ll learn how employee financial stress affects health, and efficiency and how to reduce employee turnover and keep employees engaged in their work.