When you make the decision to apply for a debt consolidation loan or seek a debt management plan, it is important that you understand the difference in the various types of debt. Essentially, there are two kinds of debt—secured and unsecured.
Being aware of and understanding the legal implications of each of these types of debt is essential to any debt consolidation loan or management plan. Only unsecured debts can be consolidated into a debt management plan, secured debts cannot. Some debt consolidation plans however, will allow these types of debts to be included in the consolidation loan. Knowing which of your debts are secured and which are unsecured is one of the first steps to successful debt consolidation.
Debt Consolidation Loan vs. Debt Management Plan
Before describing the differences between secured and unsecured debt, you should first understand the difference between a debt consolidation loan and a debt management plan. While they are very similar, they differ greatly in the types of debts that can be consolidated and in the way your existing debts a re paid off.
Debt Consolidation Loan
With a debt consolidation loan, your various debts are combined into a single convenient loan with a low interest rate. A debt consolidation loan is generally for an amount that will allow you to pay off all of your various debts. You then have only one payment each month to make to the debt consolidation company. In other words, you are able to pay off all of your previous debts in exchange for a single debt. Both secured and unsecured debts can be included in a debt consolidation loan.
Debt Management Plan
It is also possible to consolidate your debt through a debt management plan. This is probably the most popular and successful choice for debt consolidation among those who carry significant amounts of debt. Through this type of consolidation method, the debt management company negotiates with your various creditors to reach an agreement for a lower interest rate and terms of payment. Once an arrangement has been made, the debt management company pays off the various creditors each month and you only make one monthly payment directly to the debt management company. Only unsecured debts can be included in a debt management plan, as secured debts are already guaranteed by collateral and generally already carry a lower interest rate. When seeking to eliminate your debts through a debt management plan, it is generally a wise idea to pay off your secured debts as quickly as possible since you have assets at risk.
Secured Debt
Any loan that is guaranteed by an asset is considered to be a secured loan. Examples of secured loans include mortgages and automobile loans. Thus, any debts that you owe on these types of loans are secured debts. These types of loans and debts are considered secured because the lender or financial institution can seize the item that was put up as collateral for the loan if payments are not made. Unlike debt management plans, some debt consolidation plans may allow you to include your secured debts However, you may find that you are better off keeping your secured debts separate as they likely already have a low interest rate. If you include them with your unsecured debts, you may end up actually paying more on them if you would if you keep them separate.
Unsecured Debt
Unsecured debts are loans that are not guaranteed or backed up with any collateral. That is, when a lender grants you an unsecured loan, they are primarily only taking you at your word that repayment of the loan will be made. The most common types of unsecured debts are credit card and personal loan debts. Unsecured loans are a higher risk for lenders than secured loans are and result in a higher interest rate. While it is extremely important to payoff all debts as soon as possible, you should pay off your secured debts before unsecured ones, as not paying off unsecured loans in a timely manner will not generally result in the loss of any assets.
Knowing the differences in secured and unsecured debts is vital to understanding how you should consolidate your various debts. Whether you select a debt consolidation loan or a debt management plan, doing your homework and understanding your options ahead of time is key to successful debt planning and financial freedom.