What is Debt Consolidation?
Debt consolidation is a way to taking a new loan to pay off the other liabilities and consumer debt. Multiple debts are collected into a more extensive or single debt which is usually called a loan with favorable terms like low-interest rate, low monthly payment, or tenure.
It works as a tool to pay other debts like student loan debt, credit card debt, and other liabilities. The amount received from debt consolidation is utilized to pay off other small debts.
How does debt consolidation works?
It is a way to taking a loan by using other kinds of financing to pay off other debts and liabilities. If you are under many types of debts, you can apply for a loan to pay off those debts into a single liability. Payments follow a new debt structure until it is fully paid off.
People apply for debt consolidation in different ways, like through their credit union, banks, or Credit Card Companies as the first step. It is a good way to take debt consolidation, especially if you have a good relationship and payment history with your company. But if you cannot apply this way, you can try other methods like through lenders or private mortgage companies.
Creditors do this willingly because of many reasons. Debt consolidation increases the chance of collecting from a debtor. Financial institutions like banks and credit card unions offer these loans, but other debt consolidation service companies also provide this facility to common people.
Debt settlement Vs. Debt Consolidation
The noteworthy point here is that debt consolidation loans don’t remove original debt. They just transfer the consumer loan into another category or type of loan. But those people who do not qualify for loans or want debt relief may try debt settlement. It may be the best option for those people.
The purpose of debt settlement is to decrease consumer’s obligations instead of the number of creditors. A consumer may take help from debt-relief organizations or credit counseling services. These organizations try to rearrange borrower’s current debt with creditors.
What are the types of debt consolidation?
Here are two basic types of debt consolidation loans.
- Secured loans
- Unsecured loans
Secured loans: These loans are provided on behalf of borrowers’ personal assets such as houses or cars. These assets provide security to creditors.
Unsecured loans: These loans do not take any personal asset, and it is difficult to obtain. This is the reason unsecured loans have higher interest rates and lower qualifying amounts.
On both types of loans, the interest rates are lower as compared to rates charged on credit cards. Most of the time, the interest rate is fixed and does not vary with the repayment period.
Ways to combine debts
There are many ways to combine debts by consolidating them into a single payment. Here are some most common ways described below:
- Debt consolidation loans
Many lenders and traditional banks offer debt consolidation loans to manage their number of debts. These loans are designed for consumers to pay different high interest debts.
- Credit cards
The other way to combine your debts into a single payment is to collect all credit card payments into a new credit card. The new credit card will benefit you if it offers little or no interest for a specific period of time.
You can also use the existing “credit card balance transfer feature” to move your debts if it offers special promotion.
Another way to get all loans under a single payment is a home equity loan or home equity lines of credit (HELOCs) for debt consolidation.
- Student loan program
The federal government offers debt consolidation for people with a student loan. The new interest rate will be an average rate of previous loans. However, private loans cannot get this opportunity.
Advantages of consolidation loans
If you are thinking about a debt consolidation loan, think about its advantages and disadvantages. Don’t worry; we have a solution to this problem. Here we have described the advantages of debt consolidation.
- It is an excellent tool for those people who have multiple debts with high-interest rates or monthly payments.
- It is beneficial for those people, especially for those who owe a debt of $10,000 or more.
- By getting a single debt consolidation plan, you have the benefit of paying a single payment monthly instead of multiple payments.
- If you do not take an additional debt, soon you will be debt free.
Disadvantages of consolidation loans
Here are the disadvantages of consolidation loans.
- It is true that it provides low-interest rate, but you also have to look for the payment schedule. If there is a longer payment schedule, it means you are paying more for a long time.
- You must talk to the credit card issuer to determine how much time it will take to pay off the debts at the current rate and compare it with a new one.
Debt Consolidation and Credit Scores
A consolidation loan may be helpful for you to lower down your credit scores. If you pay the loan’s principal portion earlier, you can keep the interest rate lower. It also means that you will pay less money. It will also boost your credit score.
On the other hand, converting the existing loans into new ones may negatively affect your credit score. Credit scores benefit longer and consistent payment histories with longer-standing debts.
Requirements for Debt Consolidation
The borrower must have a consistent income source to qualify for debt consolidation. The documentation includes credit history, letter of employment, two-month worth statement for credit or loan, and letter from creditors or payment agencies.
When you get your debt consolidation plan money, you need to decide whom you will pay off first. In most cases, the lender decides who you should consider. However, if you have to choose this, consider the higher interest debt first and pay off that debt.