What is Debt Consolidation When and How to do it?

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Which is “Debt Consolidation”?

Consumers utilise debt consolidation to pay off a minor debt in one lump amount by taking out a single large loan. By doing this, they reduce the cost of the modest amount they owe, including financing charges and interest. The borrower would no longer be required to pay many instalments to different creditors, but only one. Consolidating debts that are not secured by an asset is possible. Unsecured debts that can be included in debt consolidation include personal loans, education loans, and credit card debt.

Debt consolidation is the process of taking a new single loan to pay off all your existing loans thereby leaving you with just one monthly payment rather than several. The theory is that one payment will be easier to manage. The goal is to lower the interest rate and the monthly payment while paying off your debt more quickly.

This loan is used to repay for any type of loan, so it is mandated to choose the perfect loan for debt consolidation. This will help you to save interest on your loan. Choosing the right loan for you includes various factors such as rate of interest, finance charges, early payoff fees and minimum credit scores. In this article, you will get to know about the best loan for Debt Consolidation.

A debt consolidation loan clubs all your debts and pending loan repayments into a single loan which is repaid at a comfortable pace. Whether it’s your medical bills, student loans, credit card debt or secured and unsecured non-asset debts, a single debt consolidation loan is your go-to solution when things begin to go out of hand. When you have multiple debts and you want to pay them off at a fixed interest rate, a debt consolidation loan is what you turn to.

How does a Debt Consolidation Loan Work?

The majority of debt consolidation loans are fixed-rate instalment loans, which means that your monthly payment is predictable and the interest rate never varies. Therefore, if you have three credit cards with various interest rates and minimum payment requirements, you may utilise a debt consolidation loan to pay them off, leaving you with only one monthly payment to handle rather than three.

Consider that you are reducing your credit card debt. You may reduce your interest expenses in the following ways with a debt consolidation loan:

  • Card 1 has a balance of $5,000 with an APR of 20 percent.
  • Card 2 has a balance of $2,000 with an APR of 25 percent.
  • Card 3 has a balance of $1,000 with an APR of 16 percent.

Your interest expenses, if you paid off these credit card amounts over the course of a year, would be $927. But suppose you obtain a personal loan for the $8,000 you owe with a 12-month term and a 10% APR. The interest cost is reduced to $440 if the loan is repaid in a year. Try utilising a personal loan calculator and a credit card payment calculator to figure out the savings on your own debt.

Pros of Debt Consolidation

  1. It is steady and efficient. You don’t have to calculate and manage EMIs on several debts anymore. You make one single payment every month till you are debt free.
  2. Debt consolidation begets you a lower interest rate on your overall loan and has longer tenure which results in smaller monthly payments to ease your burden.
  3. It reduces stress and gives you emotional and financial relief. You don’t have to worry about loans anymore other than just monthly repayment and concentrate of other important things in life.
  4. Working out your monthly budget will become a lot easier when repaying a single EMI. It will save you from accruing additional debt because you miscalculated your monthly EMIs.
  5. You can save on service fees, initiation fees, processing fees, insurance charges etc charged by several banks and use that money to pay off your monthly EMIs.

Cons of Debt Consolidation

  1. It is not always easy to find a debt consolidation loan. Even this depends on your eligibility, your current situation, amount you need to borrow, your credit history etc.
  2. While you are stressed about your current loans, don’t apply for a debt consolidation loan with several banks at the same time. This might hurt your credit score which is already low and could affect your chances of obtaining reasonably priced credit for the next few years.
  3. Debt consolidation loans might not be appropriate for everyone – for example, if you are a seasonal worker and your income isn’t consistent throughout the year, you might not want the commitment of regular monthly repayments.
  4. Reducing your debt obligation through an affordable repayment plan ends up relieving your emotional and financial stress. This relief might leave you feeling prematurely confident and can increase your spending habits again.
  5. In case of secured debt consolidation, you might put your property or mortgage at risk in the case of a default.

Types of Debt Consolidation

1. Debt Consolidation through Secured Loans 

One of the options is to consolidate all your unsecured debt to one secured debt by taking a Mortgage loan, Loan against property, Loan against your car, equity, Gold, Life insurance policy, cash value etc. The advantage of going with secured consolidation is that you will have to pay a lesser rate of interest. Because the loan is secured, it is more affordable and if it is against real estate you might also get tax deductions. Secured loans are advanced easily as they are less risky.

2. Debt Consolidation through Unsecured Loans 

This is a good option if you don’t have or don’t want to pledge your collateral and it is quite common. Many banks offer unsecured debt consolidation with lesser rate of interest than usual but higher than secured loan. Do check with the bank if they can provide you any offers such as low interest rate or no interest rate for first month or if they have any other offers for the company you work for etc. The benefit of unsecured consolidation is that your collateral is not at risk.

When you should consolidate Your Debt?

Debt consolidation can be a wise financial decision under the right circumstances—but it’s not always your best bet. Consider consolidating your debt if you have:

  • A large amount of Debt

If you have a small amount of debt you can pay off in a year or less, debt consolidation is likely not worth the fees and credit check associated with a new loan.

  • Additional plans to improve your Finances

While you can’t avoid some debts like medical loans others are the result of overspending or other financially dangerous behavior. Before consolidating your debt, evaluate your habits and come up with a plan to get your finances under control.

  • A credit Score High enough to qualify for a Lower Interest Rate

If your credit score has increased since taking out your other loans, you’re more likely to qualify for a debt consolidation rate that’s lower than your current rates. This can help you save on interest over the life of the loan.

  • Cash Flow that comfortably covers monthly Debt Service

Only consolidate your debt if you have enough income to cover the new monthly payment. While your overall monthly payment may go down, consolidation is not a good option if you’re currently unable to cover your monthly debt service.

How to consolidate your Debt?

There are primarily two methods for consolidating debt, each of which reduces your monthly debt payments to one. Obtain a balance-transfer credit card with 0% interest: Add this card to your list of debts, and then pay off the entire sum during the promotional time. To qualify, you most likely need strong or exceptional credit.

Take out a fixed-rate debt consolidation loan, use the funds to settle your debt, and then repay the loan over the course of a certain period of time. You can still be approved for a loan if your credit is terrible or fair, but consumers with better scores will probably be eligible for the best prices.