Unsecured Debt Consolidation Loans at a Glance

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Unsecured Debt Consolidation Loan
HIGHLIGHTS
  • Rates for unsecured consolidation loans vary widely.
  • Repayment terms typically are 5 years.
  • You need a high credit score to qualify for the best interest rates.

Interest Rates and Terms for Unsecured Debt Consolidation Loans Offered by Three Banks & Two Peer-to-Peer Lenders

People often think of unsecured debt consolidation loans when debt becomes a pressing issue. This article compares the rates and terms of unsecured loans from three national banks and two peer-to-peer lenders. We also look at the rates and terms for a cash-out vehicle refinance offered from Wells Fargo for comparison purposes.

But before we dive into the comparison, we need to define several terms used here. The first, of course, is unsecured loan.

Unsecured Loan

An unsecured loan does not require you, the borrower, to promise to give a thing of value to the lender if you fail to repay the loan. The "thing" of value is known as the security. In an unsecured loan, the lender has no right to seize a particular item possessed by the borrower in a process called repossession.

Common unsecured loans are credit cards, medical debt, payday loans, and student loans. Unsecured loans offered by a banks are often called signature or personal loans.

Secured Loan

A secured loan, as you probably guessed, requires you to promise to give something of value to the lender if you fail to repay the loan. The lender seizes the security in a process called repossession, and sells the security in an auction to repay all or part of the balance due.

Common secured loans are mortgages, where the lender has the right to seize the home in a process called foreclosure. Vehicle loans are secured, typically.

Interest

The cost of a loan, expressed as a percentage. From a borrower's perspective, lower is better. The interest rate is based on the lender's risk for making the loan. For example, a mortgage loan to a person who has a long history of repaying loans will be 4% or less at today's rates. On the other hand, a credit card issuer may offer a 30% interest rate to a person with a history of not repaying their loans on time.

Term

The number of payments to repay a loan. Typically, one payment is due every month. In most unsecured personal loans, the maximum term length is 60 months, or five years.

Consolidate

A tricky term to define because many people use "consolidate" to define different debt resolution strategies. The purest definition is to combine several things into one. One definition of debt consolidation is to make one payment that repays several lenders simultaneously. A debt consolidation loan is a new loan that pays off two or more old loans. An ideal debt consolidation loan replaces high-interest loans with a low-interest loan. As we see below, however, there are other strategies for resolving debt that do not involve loans.

Where to Find an Unsecured Debt Consolidation Loan

You can find an unsecured debt consolidation loan at national banks, local state-charted banks, and credit unions. The table below compares rates and terms for the national banks plus two peer-to-peer lenders.

Notice the huge range of interest rates. As mentioned above, rates for unsecured loans are higher than secured loans. A cash-out vehicle refinance from Wells Fargo can be had for as low as 4.42%, which is the range of home mortgages. Why does Wells Fargo price a cash-out vehicle refinance so low? If the borrower fails to repay the loan, Wells Fargo has the legal right to repossess the vehicle. This lowers the risk of the loan being a total loss if the buyer defaults and does not repay the loan.

Lender Type of Loan Rate Term (months) Amount
Comparison of personal loans. Source: Lender and third-party Web sites, March 2012.
Citi Personal 10.49% - 25.49% 24 - 60 $500 - $50,000
Wells Fargo Personal 10.28%+ 24 - 60 $3,000 - $100,000
Wells Fargo Vehicle cash-out refinance* 4.42%+ 12 - 72 $5,000+
US Bank Personal 5.08%+ 24 - 60 $3,000 - $25,000
Prosper Personal 6.59% - 35.84% 12 - 60 $2,000 - $25,000
Lending Club Personal 6.78% - 27.99% 36 - 60 $5,000 - $35,000
Rates vary based on borrower’s credit score. Must be existing customer at some banks to qualify.
*A secured loan.

But there is another important reason for the range in interest rates in loans — riskiness of the borrower. The riskiness of a borrower is measured by his or her credit score. A credit rating or credit score is a predictive statistic based on the borrower's history of repaying credit cards, medical bills, mortgages, and other bills. A person with a perfect history repaying a variety of accounts over a long period of time will have a higher credit score than someone who has a short or checkered history.

A lender may choose to deny the application of a person with a low credit score. Or, a person with low score may be offered a rate much higher than an otherwise identical person with a high score.

Alternatives to an Unsecured Debt Consolidation Loan

If a low credit score makes it impossible for you to find, or not economical to choose an unsecured debt consolidation loan, you have three alternatives.

The first is a cash-out refinance on your home. A cash-out mortgage refinance is possible if you own a home with equity and you have a high credit score. Follow the link just mentioned if you meet those two conditions.

The second and third options are not loans at all. Credit Counseling is a two-step service where you spend an hour with a counselor who reviews your expenses and helps you create a livable household budget. The second step of credit counseling is where the counselor convinces your creditors to agree to a debt management plan (DMP). A DMP is a five-year program where all enrolled creditors are repaid 100% of their loan balances. In some cases, the creditors agree to waive fees and reduce interest rates. Follow the link just mentioned to learn more about the positives and negatives of credit counseling.

The third option to an unsecured debt consolidation loan is debt settlement. In debt settlement, a borrower stops paying creditors entirely, and instead makes payments to a special account. Over time, the debt settlement company negotiates lump-sum settlements with the creditors for a fraction of the original amount due. How large this fraction is depends on the creditor, the debt, and the circumstances. Debt settlement takes three to four years to complete, and generally has lower monthly payments than credit counseling. The downside to debt settlement include a negative impact on the borrower’s credit score, and the possibility of litigation launched by a creditor.

Summary

An unsecured debt consolidation loan is a good idea if it cuts the interest expense of the loans you are consolidating. If you do not qualify for a debt consolidation loan, then consider your alternatives, including bankruptcy.

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