What is a debt consolidation loan? First, debt consolidation refers to consolidating or combining several loans into one big loan. A debt consolidation loan therefore refers to any loan that will let you consolidate your multiple loans. To elaborate, a debt consolidation loan is any loan that you can use to pay off your existing loans so you can combine such loans’ balances into one.
Secured and Unsecured Debt Consolidation Loan
There are two major types of debt consolidation loans: secured and unsecured. Secured debt consolidation loans refer to loans that require collateral or security before approval. Unsecured debt consolidation loans, on the other hand, do not require such collateral. Secured debt consolidation loans are much more difficult to get than unsecured loans, obviously because it has much more requirements.
However, secured debt consolidation loans also generally have better interest rates and repayment terms than unsecured debt consolidation loans. Unsecured loans’ providers carry greater risk than providers of secured loans so they have to compensate by charging a higher rate of interest. If you fail to pay your secured debt consolidation loan as per the terms of your loan agreement, the bank will simply take your collateral, auction it off and recoup their losses. Under an unsecured loan agreement, however, the bank has no collateral to sell to compensate for any losses, should you not pay your loan in full.
Secured debt consolidation loans are of various specific types. A second mortgage and a home loan are examples of secured loans which you can use for debt consolidation. With a home loan, the home itself becomes the collateral; in the case of a second mortgage, the equity you have built up in your home becomes the collateral.
Unsecured debt consolidation loans, on the other hand, include balance transfer loans from credit card companies. Credit card companies usually offer balance transfer cards which you can use to consolidate all kinds of loans.
Fixed and Variable Percentage Rate (VPR)
Debt consolidation loans also vary by the type of VPR they have; some debt consolidation loans have fixed rates while some have variable rates. Fixed-rate loans are those that are offered at a fixed rate of interest for the life of the balance barring default. In other words, if your loan agreement says standard VPR is 15%, then you will enjoy that rate for the life of your loan unless you pay late, pay below the minimum or violate your loan agreement in any other way.
Variable-rate loans, on the other hand, are offered at a rate of interest that varies with a certain index rate (say, prime rate); the interest rate is computed by adding a basic rate to the index rate. Since the index rate changes regularly, then the interest rate of the loan also varies regularly.
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