Types Of Debt Consolidation Loans

As recently as 2024, an estimated 6.7 million Britons were facing financial difficulty. Rising inflation, increased cost of living, and the ever-increasing costs of rent and homeownership mean more UK families and individuals are facing financial strain.

For many individuals, it’s about living paycheque to paycheque. For others, it’s about going without. Yet, there is a solution, and it comes from using secured debt consolidation loans that lower interest rates and reduce monthly payments.

So, what are secured debt consolidation loans, and what type of debt best qualifies? More importantly, what are the best debt consolidation loans if you own a home or other property?

Understanding good debt and bad debt

One of the more common misconceptions is that all debt is bad. Some debt is considered good debt. Owning a home with a mortgage or investing in property is often seen as good debt because you are building wealth. However, credit card debt and high-interest loans are bad debt.

A good rule of thumb is that any debt used to increase your net worth or income – such as homeownership with a mortgage or investing in your education – is better than debt used to purchase things you cannot afford – such as buying things with credit cards.

Whilst everyone likes to think they can properly manage their debt, the reality is that easy credit, like credit cards, leads to impulse buying.

The more you impulse buy with credit cards and their extremely high interest rates, the more likely you’ll face mounting debt that you’ll struggle to repay.

Even good debt can become bad if you are not properly living within your means. Whilst most UK banks, lenders, and other financial institutions use a stress test or debt-to-income ratios to determine what you can afford for a mortgage, not all UK lenders use the same calculations.

What are debt consolidation loans?

With debt consolidation loans, all your outstanding credit card debt and other bad debt loans are combined into one larger loan.

Instead of making multiple minimum monthly payments to numerous creditors, you make a single payment on your debt consolidation loan. The result is a lower overall interest rate and a lower monthly payment.

In a way, debt consolidation loans help to improve your cash position. Less of your money goes towards paying multiple debts, leaving you with more money on hand.

The two categories of debt consolidation loans in the UK

Within the UK, debt consolidation loans fall under two main categories: secured and unsecured. With secured debt consolidation loans, you borrow against an asset, such as your home or other property.

In this case, you will use your home as collateral to secure the loan. This means you’re borrowing against the value or equity within your home.

Unsecured debt consolidation loans are the exact opposite. With unsecured loans, you are not putting up any assets as collateral or as a guarantee against the loan.

Lenders therefore take on more risk with unsecured loans, which invariably means you’re charged higher interest rates, have lower borrowing amounts, and shorter repayment periods.

Secured debt consolidation loan rates are typically lower, offer longer repayment terms, and allow you to borrow higher amounts than unsecured loans.

However, it’s important to know that the lender that provides you with the secured loan can take the asset (home or property) you’ve used as collateral if you are unable to keep up your payments.

Secured debt consolidation loans

Use an existing asset – such as a home or property – as collateral against the loan.
Longer repayment terms
Lower interest rates
Higher borrowing amounts

Unsecured debt consolidation loans

No asset is used as collateral
Shorter repayment terms
Higher interest rates
Lower borrowing amounts

The best debt consolidation loans

Ultimately, the best debt consolidation loans are ones where homeowners or property owners can use these assets as collateral. Interest rates are lower.

With secured debt consolidation loans, the amount you can borrow is higher, and you have more favourable repayment options. However, not all these debt consolidation loans are the same.

Remortgage

With a remortgage, you are paying off your current mortgage with a new, higher mortgage. You are, in essence, borrowing against your home equity. This home equity is the difference between your mortgage right now and the current value of your home.

Let’s assume you took out your original mortgage to buy your home 10 years ago. During this time, you have made monthly mortgage payments that have reduced the mortgage. Meanwhile, the value of your home has increased every year.

If you purchased your home for £250,000 10 years ago and paid off £30,000, the value of the mortgage would be £220,000. However, with your home’s value now estimated at £300,000, you have essentially created £80,000 in equity within your home (£300,000 – £220,000).

It’s important to understand that with a remortgage, you will only be able to borrow a percentage of your home’s equity.

In general, UK lenders will typically allow you to access a maximum of 80 percent of your home equity. In our example, it would be £64,000. Of course, the bank or lender will need to do a new stress test or analysis to ensure you can afford the new mortgage.

Another important consideration is that with a higher mortgage amount, your monthly mortgage payments will increase. However, mortgages have much lower interest rates than credit cards and other bad debt loans.

Second charge mortgage

With second charge mortgages, you receive a loan from another UK lender other than the one who provided your mortgage.

You will still use your home as collateral with a second charge mortgage, but the interest rates you’ll pay will be higher, and the amount you can borrow will typically be lower.

The costs are higher on second charge mortgages because the lenders providing second charge mortgages take a backseat to your primary mortgage lender.

In essence, should you lose your home or be forced to sell, your primary mortgage lender would be paid first, and then the second charge mortgage lender would be paid afterwards.

Often referred to as a homeowner loan, second charge mortgages are like taking out a second, albeit smaller, mortgage on your home.

Like a remortgage, you’re able to use the equity you have built up in your home. However, unlike a remortgage, the interest rates will be higher, payment terms will typically be shorter, and the amount you can borrow will likely be lower.

Read more – Secured debt consolidation loan rates, or why not find out how much you could save using our debt consolidation loan calculator.

Unsecured debt consolidation loans

The less desirable option is to use unsecured debt consolidation loans. These loans are offered through UK banks and financial lending institutions. They are less desirable than secured loans because lenders take on more risk.

With an unsecured loan, the lender has no collateral to protect them should you be unable to keep up your payments.

While you can still lower your overall interest rates and monthly payments with unsecured debt consolidation loans, you won’t be saving as much or have as much flexibility as you would with a secured loan.

Debt management plans and companies

Finally, debt management plans and debt management companies may be able to help you reduce your monthly payments and might be able to reduce your interest rates.

These are not debt consolidation loans. Instead, they are debt management plans that are either self-managed by you or company-managed on your behalf.

Within the UK, individuals can create a debt management plan on their own with their creditors. In this case, you contact your creditors and try to negotiate lower monthly payments. Whilst this can work, it’s important to know that your creditors do not have to agree to your requested monthly payments.

With a debt management company, it’s the company itself that negotiates on your behalf with all your creditors. These debt management companies typically charge a setup fee and will charge you each time you pay your creditors.

If you decide to use a UK debt management company, ensure you use one approved by the Financial Conduct Authority (FCA). The FCA is the official regulatory authority for financial lenders and financial firms in the UK. It is industry-funded and acts as a consumer protection authority for UK residents.

Take charge of your financial future

If you are someone struggling with debt and looking for a long-term solution, we can help. As a finance brokerage firm that embraces a customer-centric focus, we help individuals better manage their finances and create lasting wealth.

From HMO mortgages, homeowner loans, bridging finance, commercial mortgages, to business loans, our team does it all. If you need help with your debt and want to future-proof your finances, contact us now.