Hey there! Are you planning to borrow money?
Most likely, you will have to make a decision about taking out a secured loan and an unsecured loan!
What is an unsecured debt?
As the name implies, it does not require any security. In other words, this type of debt has no collateral backing. If you default on this debt, the creditor can file a lawsuit against you to collect the owed amount.
One of the common examples of an unsecured loan is a credit card! Usually, the creditors offer you a credit line based on your creditworthiness and promise to repay.
Besides, your credit score and debt-to-income ratio play an important role to take out an unsecured loan. That’s why banks charge a higher interest rate on these loans.
What is a secured debt?
Creditors offer secured debt, backed by a collateral, to reduce the risk of lending money to you. If you default on repayment, the creditors can seize your collateral and sell it off to repay your debt.
It can be easier to qualify for a secured loan. The reason being, the creditors have the assurance that they will be able to recover the amount in case you default.
But how can you convert a secured debt to an unsecured one?
Paying off your car loan with a credit card
Yes, you heard it right! You can pay off your car loan with a credit card. You might think that since auto loan is a secured one, how will it be possible to pay off with a credit card?
It’s possible! It solely depends on your lender whether or not he/she accepts credit card payments. Some lenders accept credit card payments but with a hefty processing fee.
You can opt for a credit card that has 0% APR (Annual Percentage Rate). You can transfer your auto loan balance to the credit card. Doing so, you can repay your auto loan with 0% interest rate!
But usually, credit card companies offer a 0% APR for a limited time. So, try to pay off your debt within that introductory period.
Thereby, you are converting your secured debt, i.e, auto loan to an unsecured credit card! And you can save money on the interest payments, if you can repay within the introductory period!
Transforming your secured credit card into an unsecured one
Let’s say, you have no or very low credit score. But you need a credit card! So, what will you do then?
The solution is to opt for a secured credit card! With such a card, you will have to deposit some assets as collateral for the creditor.
Well, you might be thinking that credit cards are usually unsecured ones. Then why are you keeping collateral for taking out a credit card?
Buddy, as you have a very low or no credit score, you don’t have anything to show your creditworthiness!
But if you can establish responsible behavior while using a secured credit card, you can qualify for an unsecured one!
Yes, you can convert your secured debt into an unsecured one! You have to charge your credit cards for small amounts. And make sure to pay off your outstanding balance amount in full and on time, within the grace period
Your creditor might be satisfied if you make the minimum payment only. But your goal should be to pay off the whole amount you have charged in that billing cycle.
If you continue doing so, your credit score is likely gonna improve. And the creditors might offer you an unsecured credit card!
Well, let’s say, you have got qualified to opt for an unsecured credit card and you are using it! But due to some financial crunch, you have fallen prey to the debt trap!
Then what is the solution?
The best way to convert your unsecured credit card debt to a secured one is by consolidating your debts by a Home Equity Line of Credit (HELOC).
It is also known as a “second mortgage” as you are taking out an additional loan on a house that already has a mortgage.
When you take out a HELOC, you are borrowing from the bank keeping your home as collateral. Like a credit card, it is a revolving loan.
However, unlike a credit card, a HELOC comes with a time limit! It means that you can borrow money for a certain period like 5 to 10 years, known as the “draw period”. During this phase, you can withdraw money upto your credit limit only by making the interest payments on the principal amount!
After the draw period is over, most of the HELOCs will have a repayment period of around 10 to 20 years. You have to make regular payments for the principal and interest until your loan is paid off!
But you know what?
With a HELOC, you are borrowing against your home equity (the value of your home – the amount you owe on your primary mortgage). In other words, you are taking out a secured loan to pay off your debt! So, you have to keep in mind the following things:
- (i)You might lose your home if you don’t make payments as your home is the collateral.
- (ii)You need to have certain equity to opt for a HELOC. Usually, a HELOC can let you borrow up to 85% of your equity!
- (iii)Most likely, you will need a debt-to-income ratio in the lower 40s and a credit score of 620 or above to take out such a loan. Besides, the value of your home should be at least 15% more than you owe.
However, it is somehow better than an unsecured personal loan. Usually, HELOC interest rates are variable. That means, they are based on the Prime Rate plus 1% or 2%. The average HELOC interest rate in August 2019 was around 6.57%. As you can see, the interest rate of HELOC is comparatively lower than that of an unsecured loan!
So, you can consolidate your high-interest unsecured debts by using a HELOC as it has a lower interest rate! And thereby, you can certainly save money on interest payments by converting your unsecured debt into a secured one!
So, as you can see, you can convert your unsecured debt into a secured one and vice versa. But you have to keep the important things in mind which are mentioned in this article.
And don’t forget to let us know about your experience!