When you apply for a loan, your lender will assess your financial situation and review your credit before determining if you’re approved. Eligibility requirements will vary depending on the lender you choose, but may include good credit, a manageable debt level, and stable income. These factors signal to your lender that you’re likely to repay your debt.
But strict eligibility requirements aren’t the only measure lenders use to protect themselves. Certain loans are secured, meaning that the loan is supported by collateral the lender can repossess if the borrower defaults. This serves as an added measure of protection.
So which types of loans are secured, which are unsecured, and what are the benefits of each type? We’ll answer that question below and explain how it might apply to your student loan situation.
What Is a Secured vs. Unsecured Loan?
Secured debt has collateral behind it, which the lender can take if the borrower stops making payments. Mortgages, home equity loans, and auto loans are common types of secured loans.
Unsecured loans, such as personal loans and student loans, have no collateral behind them. If you default on an unsecured loan, the lender cannot collect anything in response. For example, both private and federal student loans are unsecured debt, so the lender can’t take away your diploma if you miss payments.
| Pros | Cons | |
| Secured loans | May have more flexible qualifying requirements May have lower rates | Lender can take collateral if you stop making payments |
| Unsecured loans | No collateral required Less risky overall | May have stricter qualifying requirements |
To be clear, both federal and private student loans are unsecured debt. No matter which type you apply for, you won’t need to offer up any collateral. You also won’t need to meet any qualifying requirements, such as having good credit, for federal student loans, though you will need to complete the Free Application for Federal Student Aid (FAFSA) each year to be eligible for federal aid.
Private student loans, or those you obtain from a private lender, may have certain qualifying requirements in place. For instance, some lenders might have a minimum credit score requirement or only accept a debt-to-income ratio below a certain threshold.
Can You Convert Unsecured Loans to Secured Loans?
When you have an unsecured loan, such as a student loan, there are a couple of ways you could convert it into a secured loan. But you’ll want to weigh the pros and cons of a conversion like this before you move forward. The biggest drawback is that your new lender can take your collateral if you stop making payments.
Home Equity Loans
If you’re a homeowner, the most common conversion is to take out a home equity loan and use the proceeds to pay off your student loans. A home equity loan, which is essentially a second mortgage, lets you borrow against your home and receive the excess equity in cash, which you can then use to pay off student loans.
Interest rates on home equity loans are typically higher than those of regular mortgages and may also be higher than student loan rates, depending on your lender. You’ll generally need good credit, a manageable debt level, and stable income to qualify for a home equity loan.
Cash-Out Refinance
Another option is a cash-out home refinance. To qualify for a cash-out refinance, you’ll generally need at least 20% equity in your home, good credit, manageable debt, and stable income. With a cash-out refinance, you can refinance the home into a new loan and receive the extra equity as cash. You can then use those funds to pay off your student loans.
You will only have one home loan with a cash-out refinance. However, the downside is that your mortgage balance will be higher than it was before. This means you may end up paying more in interest over the life of the loan.
Another risk with a cash-out refinance is that you might have a problem later on if housing prices fall and your home is worth less than your mortgage balance. In this case, you will be unable to sell the home unless you can come up with the difference between the mortgage balance and the sale price.
Refinance Student Loans to Save Money
If you’re wary of using your home’s equity to pay off your student loans, there is another way to save on student loan interest. You could refinance your student loans with a private lender to get a lower interest rate. Just be aware you’ll sacrifice some benefits of federal student loans, like income-driven repayment, when you go this route.
ELFI can help you refinance both federal and private student loans, and borrowers can choose a fixed interest rate or a variable interest rate. Fixed-rate loans have a consistent rate during the entire loan term, while your rate will fluctuate with the market with a variable-rate loan.
ELFI offers five, seven, 10, 15, or 20-year terms. Longer loan terms will have lower monthly payments, while shorter loan terms will have higher monthly payments. Interest rates are higher for longer loan terms and lower for shorter loan terms. When deciding between loan terms, choose a monthly payment you can comfortably afford.
