Debt Consolidation: Loans vs Programs–Which Is Best For You?
If like many of us, you need help to pay off multiple debts, debt consolidation may be right for you.
With it, you effectively combine two or more of your individual debts into one, which you then pay off monthly with a fixed interest rate. The purpose of debt consolidation is to streamline your debt payment process and save money through lower interest rates.
This is also another form of debt refinancing. Here we’ll look at two popular ways to consolidate your debt: through debt consolidation loans, and through debt consolidation programs.
Who Offers D.C. Loans?
A common way to consolidate your debts is to take out a debt consolidation loan. That is a loan that you use to pay off a number of smaller loans, month by month, at a fixed interest rate.
To be clear, when you make use of a debt consolidation loan, you are not technically combining all your smaller, individual debts into one large loan and then paying for it. Rather, what you are doing is using the money from a new, lower interest loan to pay off smaller, existing debts that you would like to consolidate with monthly payments.
Secured vs Unsecured Debt
There are two different kinds of debt: secured debt and unsecured debt. In most cases, debt consolidation loans only cover unsecured debts.
The main difference between secured and unsecured debt is that, unlike secured debt, unsecured debt has no collateral backing. That means it does not require security and, if the debtor defaults on the unsecured debt, the lender will either collect what is owed or file a lawsuit.
Also, most unsecured debt, unlike secured debt, is relieved by bankruptcy.
If you need help to consolidate debt, it helps to know that unsecured debt instruments are only backed by the credit and reliability of the entity that issues them. Because of this, unsecured debts come with higher risks, and interest rates are typically higher.
Lenders issue unsecured loans based on debtors’ promise to repay and credit.
Examples of unsecured debt are:
- Outstanding balance on credit cards
- Student loans
- Personal loans (also known as consumer loans)
Examples of secured debt are:
- Car loans
- Certain credit cards
- Bank loans
- Residential mortgage loans
- Auto loans
With secured debt, the item being financed becomes the collateral for the financing.
Consider how mortgage payment works. As a secured debt, your mortgage payment is secured against the value of your home. That means that, until you fully pay off your mortgage, the lending institution maintains a financial interest in the property until you have fully paid off your mortgage. If you do not make required mortgage payments, in order to recoup the credit they extend to you, your lender can legally repossess or foreclose your property.
The borrower has more to lose by neglecting payments on their mortgage, or other secured debts. As a result, secured loans are less risky for lenders, interest rates are typically lower compared to those of unsecured debt, and consumers can typically obtain secured debt financing more easily than they can unsecured debt financing.
Who Offers Debt Consolidation Loans?
Only certain lending institutions are authorized to issue debt consolidation loans: banks, finance companies, and credit unions. Typically, these institutions issue debt consolidation loans in either one of two ways:
- Either the lending institution will deposit the consolidation funds into your bank account, meaning you are responsible for paying off the debts that you would like to consolidate; or
- you use the consolidation funds that the lending institution lends to you in order to pay off the debts you have previously agreed to pay off.
To qualify for debt consolidation loans, consumers typically need to have good credit. Don’t worry if you do not qualify for debt consolidation loans. There’s another common way to consolidate debts: through debt consolidation programs.
Debt Consolidation Programs
Debt consolidation programs (DCPs) cover unsecured debts, such as personal loans and credit cards.
With a DCP, you make an arrangement between a non-profit credit counseling agency and your creditors. A certified credit counselor works on your behalf. Typically, one-on-one, to round up all your unsecured debts into one more affordable monthly payment. The credit counselor will also try to have the interest on your unsecured debt dropped.
Not only that, but a certified credit counselor may offer advice and strategies for debt management!
Note that a DCP is not the same as a debt management plan.
For some, DCPs can provide faster debt relief than debt consolidation loans. A DCP often includes agreements by creditors to waive late fees for payments. This includes what you have missed in the past or to reduce interest rates on outstanding balances. Other benefits of a DCP may include \automatic and timely payments to creditors and no more collection calls.