Using an unsecured loan to consolidate debt: What to know

It’s normal to have debt. When you're ready to take control of your finances, a great first step is to learn about your options for paying down your debt. 

Many people find debt consolidation loans to be very helpful in their debt payoff journey. By transferring your existing debt to a new loan, you could get an easier-to-manage payment, and possibly even pay back your debt sooner. Let’s see how debt consolidation loans work so that you can figure out if it’s a good option for you, too. 

What is an unsecured debt consolidation loan?

An unsecured debt consolidation loan is a personal loan that doesn’t require collateral. You borrow a lump sum to pay off more than one existing debt, then repay the new loan in fixed monthly payments.

Collateral is something you agree to give your lender if you don’t repay the loan. For example, your car is the collateral for your car loan. Since personal loans don’t use collateral, approval is based on your credit standing and financial situation. 

Lenders usually charge slightly higher rates on unsecured loans compared to secured loans that have collateral. Even so, unsecured personal loans tend to cost less than credit cards. Many people use unsecured consolidation loans to pay off debt with higher interest rates, like credit cards. 

How does it work for debt consolidation?

When you get an unsecured personal loan for debt consolidation, you move existing debt to a new loan. Your new loan may come with friendlier terms that make it easier to repay the debt, such as by getting a lower monthly payment. Let’s see how the debt consolidation process works, step by step:

1. Get pre-qualified for the loan by entering a few basic personal and financial details. 

2. Submit a full application when you’re ready to apply. 

3. If your application is approved, your lender will send you the loan funds.

4. Use the loan money to pay off existing debt.

5. Start paying back your new loan with monthly payments.

Unsecured personal loans usually come with term lengths ranging from two to five years. These loans often charge fixed interest rates, so you don’t need to worry about your payment changing from month to month. 

What’s the difference between secured and unsecured loans?

Personal loans for debt consolidation are usually unsecured, which means that you haven’t pledged any collateral to back up your loan. You might also come across lenders who offer secured loans for debt consolidation, which means that you borrow against something of value, like your home. A HELOC for debt consolidation is a secured loan.

If you have the option of using collateral with a secured debt consolidation loan, you can gain access to a few benefits. For one, it might be easier to qualify for the loan. If you are approved, you could get lower interest rates, which makes it easier to pay back your debt. The key thing to remember with secured loans is that your collateral is at stake. In other words, if you don’t repay the loan, the lender can take your collateral and sell it to recover the money you owe. 

Read more: Secured vs. unsecured loans: understanding the differences and making the right choice

How to qualify for an unsecured debt consolidation loan

Most lenders check to see if you meet certain requirements when you apply for a debt consolidation loan:

• Income: Lenders prefer applicants with steady income.

• Credit score: Most personal loans require a good credit score. The minimum credit score could be 620 to 700.

• Debt-to-income ratio: Ideally, your minimum debt payments and housing shouldn’t take up more than 35-50% of your monthly before-tax income. 

Remember, each lender has different requirements for unsecured debt consolidation loans. If you don’t qualify with one lender, you can try shopping around with other lenders. In fact, experts recommend checking your loan options with at least three lenders before choosing one.

Can I check my rate without hurting my credit?

Yes. Most lenders allow you to check your rates without impacting your credit. This uses a soft credit check, which doesn’t impact your credit score like the hard credit check that lenders do when you formally apply for the loan. A hard credit check could lower your credit score by a few points temporarily. 

Look for key words and phrases for each lender you get pre-qualified with, such as “this won’t impact your credit” or “we use a soft credit inquiry.” These are your clues that it’s safe to check your rates with that lender, without it causing any negative impact on your credit score. 

Pros and cons of unsecured loans for debt consolidation

Pros:

• Possibly lower loan fees

• Quick loan funding

• Fixed interest rates

• Doesn’t need collateral

• One monthly loan payment

• Lower risk of home foreclosure

Cons:

• Smaller loan amounts

• Higher credit score required

• Higher interest rates than secured loans

• Usually not big enough to pay off all debts, like mortgages or student loans

• Pay more total interest for loans with long term lengths

When an unsecured loan might not be the right fit

A key part of taking control of your finances is knowing when to explore other options. Here are some signs that an unsecured debt consolidation loan might not be the right fit for you:

• You have a lower credit score.

• You have a high debt-to-income ratio.

• Your monthly payments wouldn’t be affordable. 

• You’d rather use your home as collateral in order to get even lower rates. 

• The interest rates on your consolidation loan offers are the same—or higher—than what you’re paying now. 

It’s OK if an unsecured debt consolidation loan isn’t in the cards for you. Some lenders may allow you to add a co-borrower with higher creditworthiness to your loan, if they’re OK with helping you repay the loan if needed. You can also consider applying for a secured debt consolidation loan or using another tool like debt resolution.  

What’s next?

• Gather details on each of your current debts, like the interest rate, balance, and term length, so you can compare them with debt consolidation loan offers. 

• Check your eligibility and rates for an unsecured debt consolidation loan by getting pre-qualified with at least three lenders.

• Use a debt payoff calculator to see whether consolidating your debt can help you pay it off sooner. 

• Learn about personal finance tools like budgeting apps that can help you stay out of debt.