Have you been overwhelmed with loans and struggling to cope with various debt payments each month? Or perhaps your interest rates are above average and your debts are costing you a lot of money?
If you answered yes to one or both of these questions, a debt consolidation loan may seem like an attractive option in these situations. However, it is important to understand how debt consolidation works and to be sure that it will benefit you!
It is also important to remember that debt consolidation is not the solution to bad financial habits. You still need to take care of things like your financial discipline, overspending, budgeting, and creating a debt repayment plan. All of this applies to your financial well-being, whether or not you decide to consolidate your debt.
What is debt consolidation?
Debt consolidation is the process of combining debt payments into one payment (or as few payments as possible). It is most commonly used to pay off credit card debt, student loan debt, and other types of unsecured debt such as medical debt or payday loans.
How debt consolidation works
The idea is that you take different debt obligations and combine them into one big package. To do this, you must find a debt consolidation option on better terms.
So, instead of making multiple monthly payments to different creditors, you only have to make one monthly payment after debt consolidation.
When consolidating debt, it is important to fully understand the repayment terms. You also need to be sure that you understand how it will affect your finances in the long run.
Types of debt consolidation loans
There are currently two types of consolidation available on the market:
- consolidation loans secured by real estate or any other valuable property;
- unsecured consolidation loans (no collateral involved).
Most creditors are ready to work with any debts, but they determine conditions for the debt consolidation procedure on an individual basis. According to this, the terms and cost of servicing a loan will differ and not always meet the borrower’s expectations.
- Choose a creditor. If you have a good credit history, the doors of almost all credit institutions are open to you. However, if your credit score is low, you will probably have to choose small creditors;
- Do paperwork: government-issued ID, statements on all loan obligations, proof of income, employment confirmation. If you apply for a secured loan, then a certificate of ownership is also added to this list;
- Fill out an application, attach documents, go through credit scoring and wait for the lender’s response. If approved for a loan, it remains to discuss the details with the lender and conclude an agreement. Never sign an agreement until you carefully study all the clauses.
Does debt consolidation hurt your credit score?
In the short term, your credit score may go down if you decide to consolidate your debt. This is because you open a new line of credit and transfer a lot of debt to it.
Depending on how long it takes your creditors to update the credit bureaus, your credit report may temporarily show both your multiple debt accounts and your new consolidated debt.
In addition, a request for a new line of credit may result in a temporary downgrading of your credit score.
Is debt consolidation the same as paying off debt?
Debt consolidation is not the same as paying off debt. When paying off a debt, you enter into an agreement with your creditors to pay less than you owe. This payment will be made as a lump sum.
Lenders are not legally empowered to enter into debt settlement negotiations, but they may be open to doing so if they can get a certain amount of their money back.
Paying off debt can also affect your credit score, and the negative report remains on your credit report for seven years.
Who should apply for a debt consolidation loan?
Debt consolidation can help you if you:
- are ready to get out of debt;
- commit to no more borrowing money;
- owe more than $5,000;
- want to lower monthly payments and/or interest rates;
- want to simply combine multiple debt payments into one lump sum payment;
- encountered actions from collection agencies that you need to resolve;
- have done your calculations and know that a debt consolidation loan will save you money even with all the associated fees.
Debt consolidation loan: explore the benefits
For people who have fallen into a debt hole, a debt consolidation loan provides many advantages.
- It’s convenient. In this way, it will be possible to quickly put things in order with all debts, in particular: credit card debts, small loans and large personal loans, and sometimes mortgage debt can also be added to this list;
- It’s profitable. Funds will be issued for a long period and at a low interest rate. And this is a great opportunity to quickly get rid of small debts with high interest rates or, finally, pay off your mortgage;
- Debt consolidation does not have a negative impact on your credit history. On the contrary, it helps to keep it good. After all, if the debt load of the borrower is too high, and incomes barely allow you to cope with payments, then delays in payment cannot be avoided. And with the debt consolidation service, you will be able to get more financial freedom and time to search for additional funds and plan timely loan repayment.
Things to consider when taking a debt consolidation loan
Consolidation, like any loan, involves certain repayment terms, which must be carefully checked before signing the contract. What elements of a loan consolidation obligation are important to a borrower?
- Installment after consolidation – specifically its amount;
- Fee – lenders usually charge an origination fee;
- The actual annual interest rate – but it does not include additional fees;
- Total amount due – it should be as low as possible, but keep in mind that it will eventually be greater than the amount of previous liabilities;
- Collateral – for example, a mortgage consolidation loan may be secured by real estate;
- Late payments and their consequences.
Conclusion: is it worth consolidating debts?
The most important thing to remember about debt consolidation is that it does not reduce your debt. It simply moves your debt from one place to another, usually on better terms.
If you decide to take a debt consolidation loan, you should develop a debt repayment plan as quickly as possible.