How to Consolidate Secured Debt Into One Loan

By: Rebecca K. McDowell | Reviewed by: Ryan Cockerham, CISI Capital Markets and Corporate Finance | Updated February 10, 2019

If you're burdened by too much debt, you might feel suffocated and unable to move forward. If your debt is primarily secured debt, you might feel even more stuck, because you've put up property as collateral. If you default on a secured loan, the lender can take the collateral from you. Debt consolidation is one way consumers can manage their debt, and it is possible to consolidate secured debt.

Tip

A debt consolidation loan can help you make multiple debts into one manageable debt. However, if your debts are secured, the process is more complicated because of the lenders' interests in collateral.

Secured Vs. Unsecured Debt

Secured debt is secured by an interest in collateral, while unsecured debt has no security. Secured loans usually have lower interest rates than unsecured loans, because the lender has the collateral to protect itself and, therefore, has a lower risk.

Examples of Unsecured Debt

Unsecured debt is any debt incurred without offering up collateral. Credit cards, personal loans and medical bills are all general examples of unsecured debt. When you use your credit card, the credit card company doesn't have a lien on any of your assets; it just charges you an interest rate for using its money. If you don't pay the bill, the credit card company can sue you and has to get a judgment against you before it can try to take any of your property to satisfy the debt.

Examples of Secured Debt

The most common types of secured debt for consumers are car loans and home mortgages. If you borrow money to buy a car, the lender will require that you give it a security interest in the car. This means that the lender has a lien on the vehicle, and if you default on your payments, it can repossess the car and sell it to satisfy the debt.

Home mortgages are similar, although a house cannot be repossessed. A mortgage lender must commence your state's foreclosure process. Still, the result is the same: the lender has an interest in the collateral (the house or the car) and that interest lasts until you pay the lender in full.

What Is Debt Consolidation?

Debt consolidation occurs when you take out a larger loan to pay off two or more smaller loans. You may take advantage of a credit card company's balance transfer offer, for example, and pay off two smaller credit cards for a lower interest rate. The credit card you used to pay them off now has one larger balance, and the debts are consolidated.

Why Consolidate Your Debts?

People consolidate their debts for a number of reasons; you might want to reduce your interest rate or your monthly payment, or maybe you just want the simplicity of a single monthly payment instead of two or more. In any case, debt consolidation is often a first step in getting a handle on debts that are becoming difficult to manage.

Secured Debt Consolidation

Secured loan debt relief is not out of the question; you can consolidate secured loans. However, you'll have to make sure the secured lender is paid in full to get your collateral released, and in some cases, you might need to give collateral to the new lender (this is almost always true when consolidating a home mortgage).

Consolidating Home Mortgages

A common type of secured debt consolidation is a mortgage refinance. For instance, if you have two mortgages on your house, you might want to consolidate them into one. To do this, you'll need to choose a lender with favorable terms for a refinance.

The lender will need to appraise your house to make sure that it's worth enough to cover the loan you want to get. For example, if you want to consolidate a first mortgage with a balance of $100,000 and a second mortgage with a balance of $30,000, you'll need $130,000, but the lender will only give you that amount if the house is worth that or more.

Once the refinance is approved, the new lender will pay the old mortgages off, and you'll need to sign new mortgage documents giving the new lender a mortgage on your house. The old lenders will file releases or discharges of the old mortgages with the county.

Personal Property Refinance

Secured loans are also made for personal property (any property that isn't real estate). Car loans are the most common, but secured loans can also be made for buying things like large appliances or other big ticket items. The lender agrees to give you the money, but in return, you give the lender a lien on the property you're buying.

Secured loans on personal property can be refinanced, just like a house loan. The new lender will assess the value of the property to make sure it's worth as much as the loan, and then it will pay off the old loan. You'll make your loan payments to the new lender, and the new lender will have a lien on the property.

Debt Conversion: Secured to Unsecured

One strategy for debt consolidation is to convert secured debt into unsecured debt. You might do this by using a credit card with a high limit to pay off a car loan. The car lender, having received the full balance due, will release its lien, and you'll own the car free and clear. Converting secured debt into unsecured debt may seem particularly attractive if you have a 0 percent balance transfer offer from one of your credit cards.

You may also do this by obtaining an unsecured personal loan. Large banks like Bank of America and Wells Fargo often offer unsecured loans or lines of credit that they market towards people who have high credit card debt, offering to consolidate the debts into one lump sum at a fixed interest rate. Typically, you can use these personal loans for whatever you'd like, and although the goal is use them to pay off your other unsecured debt, you could also use them to pay off a secured debt to release liens from your collateral.

Secured to Unsecured Conversion: Interest Rate Tango

It's important to remember that if you do use a credit card to pay off a secured debt like a car loan, you'll have to pay the loan back at an unsecured interest rate. Credit cards have higher interest rates than secured loans because of the higher risk. While a car loan may have a rate of 3 percent to 5 percent (the national average for 60-month loans at the end of 2018 was 4.9 percent), credit card interest rates are typically anywhere from 10 percent to 20 percent (the average national rate as of January 23, 2019, was 17.51 percent).

If you use a 0 percent balance transfer offer to pay off a car, you'll incur a balance transfer fee, but also have to pay a much higher interest rate if you don't pay the balance off before the introductory rate expires.

Example of Using a Balance Transfer Promotion to Pay a Secured Debt

Say you have a credit card with a $20,000 spending limit and no balance that offers you a 0 percent promotional APR for one year on balance transfers. After the year is over, any remaining balance reverts to the standard APR for purchases, which in your case is 15.5 percent.

You also have a car loan, and you still owe about $15,000 on the car at a 3.5 percent interest rate. You could request the balance transfer funds to be direct deposited into your bank account, then use the money to pay off the car. The auto lender will release the lien, and you'll own the car outright.

The problem is that you'll need to pay that balance off within a year or the rate will jump to the standard APR of 15.5 percent. If you're not able to pay the entire $15,000 during the promotional period, you'll have to pay 15.5 percent interest on the remaining balance.

But watch out; if your promotional rate was for deferred interest, you might suddenly find that you're paying interest on the entire $15,000.

Deferred Interest or Waived Interest?

Some 0 percent promotions offer to waive interest for the promotional period. That means that as long as you pay on time, at least the minimum amount, you won't be charged interest during the promotional period.

Deferred interest, on the other hand, means that the interest is calculated on the entire balance: what you would've paid in interest had you not had the promotion. If you don't pay the full balance before the end of the promotional period, you'll need to pay interest on the remaining balance, plus interest on what you already paid for. It's sneaky, and if you're going to use a promotional rate, make sure the interest is waived, not deferred.

Changing Secured Debt to Unsecured Debt: A Bankruptcy Caveat

If you're trying to avoid bankruptcy by consolidating debt and trying to manage it on your own, you may find success. However, if you find that you just couldn't make it work and bankruptcy is looming in your future, the use of your credit card to pay a secured loan might give you a headache in your bankruptcy case.

A secured creditor is in a better position in bankruptcy than an unsecured creditor. When you file bankruptcy, you can discharge most types of unsecured consumer debts, including credit cards. However, if you have a secured debt, like a car loan, you have to pay it back if you want to keep the car (although if you give the car up, you won't owe anything).

If you use a credit card to pay off your car, the credit card company might object to your discharging the debt, and objections to discharge in bankruptcy can create a long, expensive process. Talk to your bankruptcy lawyer about how that conversion to unsecured debt might affect your case before you file.

Debt Consolidation and Credit Rating

Debt consolidation can have an impact on your credit rating. The new lender will look at your credit report, and credit inquiries can impact your score; if you have a lot of inquiries, your rating may lower.

Further, if you consolidate two small loans into one larger loan, your loan balance to available credit ratio is also affected. Your credit rating decreases if you have a lot of debt compared to available credit. For example, if you have available credit of $5,000 and you owe $2,000 on one card, the ratio is 40 percent, and if you have available credit of $5,000 and you owe $1,000 on another card, the ratio is 20 percent. If you consolidate the $3,000 onto one card with a limit of $4,000, the ratio is 75 percent, and that can reduce your credit rating.

Tip

  • You can check your credit on your own before applying for a loan. The government's Annual Credit Report website allows consumers to obtain one free copy of their credit report from each of the three major bureaus each year.

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About the Author

Rebecca K. McDowell is an attorney focusing on creditor and debtor law. She has a B.A. in English and a J.D. She has written finance and tax articles for Pocketsense and eHow.

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