You may have heard that consolidating debt is an option when looking for relief from financial stress.
But what exactly does it mean to “consolidate debt”? Let’s look at what it is and how you can go about it.
Debt consolidation is a form of refinancing. This means taking out a new loan to pay off two or more other debts, such as personal loans and credit cards. Multiple debts are combined into one larger loan, usually with a lower interest rate, lower monthly repayment, or both.
While any use of one form of financing to repay other debts is practicing debt consolidation, there are specific loans called debt consolidation loans, to help individuals who have difficulty managing the number or size of their outstanding debts.
There are two broad types of debt consolidation loans: secured and unsecured. Secured loans are guaranteed by an asset of the borrower, most commonly a house (in the form of a refinanced mortgage) or car. Unsecured loans are not backed with collateral, and may be more difficult to obtain. They may also incur higher interest rates (though generally still lower than credit card rates).
Generally, debt consolidation loans need to be paid off within three to five years.
You can apply for a debt consolidation loan through lending institutions such as a bank, home loan lender or debt relief administrator. They will assess your financial situation and advise which loans are available and appropriate to streamline your debt burden.
Moving multiple debts to a single consolidation loan can be advantageous for a number of reasons. Not only does it lessen the stress of dealing with numerous creditors, there is only one repayment to schedule. This can help individuals to avoid missed repayment charges across creditors.
Having only one monthly repayment also makes it easier to predict your monthly expenses, giving you more control of your finances.
As with any financial commitment, it is best to be aware of the potential pitfalls of taking out a consolidation loan.
Your interest rate and monthly repayment may be less than compared to the previous debts, however if your loan term is substantially longer than that of your previous debts, you may end up paying more in the long run.
Taking out a new loan may have a modest negative impact on your credit score initially. Further, your debt-to-credit ration will rise, which will also negatively affect your score; over time you can improve your score with each repayment made. And as with any type of credit account, missed payments will go onto your credit report.
It’s also important to take notice of the fees and charges involved in taking out a debt consolidation loan. It’s worth comparing loans and seeking financial advice to ensure you take up the best debt solution for your personal situation.
Consolidating your debt can be a great tool to help you manage your finances better, along with improving spending and saving habits.