Consumers are familiar with loans geared for specific purchases, like an auto loan or a home mortgage. These are examples of secured loans, because the assets in question are considered secured debt. In both cases, the car or home doubles as collateral for the lender in the event a borrower defaults on payment.
Unsecured personal loans, on the other hand, cater to several use cases and are growing in popularity. Beyond funding a major purchase, personal loans are also used for debt consolidation and repayment. For consumers looking to simplify several debts, consolidation can turn the headache of multiple monthly bills into one monthly bill. Consumers also have the opportunity to lower their combined monthly payment through debt consolidation, and potentially find a better interest rate depending on their credit score.
What kind of debt is most commonly consolidated through a personal loan? Typically, consolidated debt is in the form of unsecured debt (i.e., the opposite of secured debt).
What is Unsecured Debt?
Unsecured debt is any debt that is not backed by collateral. If a borrower defaults on an unsecured loan, the lender has limited ability to recover their investment as no assets have been promised as security for the loan. As a result, a loan applicant’s credit report plays a big role in the type of offers they’ll receive from lenders.
Below are some examples of unsecured debt that you can consolidate through a personal loan.
Credit cards make up 56% of consumer debt consolidations, according to a Google survey, the highest among all debt categories. While the best plan is to pay your full monthly balance on time, to avoid interest and penalties, many Americans are dealing with mounting credit card debt. In addition to the money they owe, having a high account balance can also negatively affect a consumer’s credit score.
For people managing debt on multiple cards, a consolidation loan could help by lowering their credit utilization ratio (ie., the percentage of debt compared to the credit limit). The consumer will then repay the loan on a monthly basis, but at a fixed APR potentially lower than their credit card interest rate. It’s important to know in advance if the lender requires you to close your credit card accounts, as doing so can affect your credit score. (Some lenders allow borrowers to keep their prior accounts open.)
It may seem like an extraneous task, but personal loans can also be consolidated into a new loan. In this case, a borrower would be incentivized by simplifying multiple monthly payments into one payment, or by finding a more attractive loan offer. For example, a consumer may have taken out their prior loans at a higher interest rate and, thanks to better existing rates and their own improved credit score, can take advantage of a lower fixed APR on a new loan. Personal loans account for 23% of consumer debt consolidations.
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A consumer may also experience debt woes from unpaid medical bills, another form of unsecured debt. When a medical bill becomes past due or delinquent, health care providers can eventually turn the debt over to a collections agency, which can result in interest charges and a negative effect on your credit report. By paying off the debts with a personal loan, a consumer can set up a monthly repayment plan that best fits their budget.
Just note, there are typically more opportunities for debt management and forgiveness with medical bills, so a consumer should always explore their full options before considering a personal loan.
Dealing with varying bills is never easy—and often overwhelming. For consumers managing multiple unsecured debts, personal loans can help simplify and reduce monthly payments, while also providing better interest rates depending on the borrower's credit. Use Fiona to find a personal loan offer that best fits your debt consolidation plan.