How Does Loan Consolidation Work?

So maybe you’ve heard of loan consolidation. But you want to know all the ins and outs of your options, the benefits as well as the risks, and also how to go about consolidating your debts.

Read on for loan consolidation 101, and whether it might be right for you.

Loan consolidation – how does it work?

Loan consolidation is the act of merging a number of smaller outstanding balances into a single, larger debt. These smaller debts may be from credit cards, store cards, personal loans and car loans, though there are even more types of debts you can consolidate.

Generally, the new loan is used to repay all of the smaller debts. You are then responsible for making a single monthly repayment to repay your new loan.

Loan consolidation options

Unsecured loan: When you have a range of debt types, taking out an unsecured loan is an easy way to streamline your repayments. With an unsecured loan, you aren’t required to put up collateral, so you’re not risking losing your home, car or business should you be unable to meet repayments.

Mortgage refinance loan: If you have an existing mortgage with equity, one of the easiest ways to pay off your debts is to apply for mortgage refinance. Most home loan lenders will allow you to borrow up to a total of 80% of the value of your property.

Credit card balance transfer: If all of your debts are from credit cards, you can apply to have the outstanding balances transferred to a new credit card. Many providers offer an interest free period on balance transfers.

Benefits of loan consolidation

There are numerous reasons why people choose a consolidation loan. Here are our favourites:

  • Financial savings: you can lock in a potentially lower interest rate (you should aim for lower than the average interest rates of your current debts), plus a single loan fee schedule.
  • Convenience: a single repayment, as well as only dealing with a single creditor.
  • A clear end date: you have a set timeline as to when you’ll be debt free.
  • Improved credit rating: having one debt, well managed, is a good way to improve your credit score.

Risks of loan consolidation

If you choose to refinance your mortgage, it is important to recognise that your asset is being used to secure the debt. This means that if you were to fall behind in repayments, the lender may legally seize your property in order to recoup their loss.

With a credit card balance transfer, you will find yourself with “full” credit cards. Make sure you don’t begin the debt cycle all over again and remove the temptation to spend by closing your accounts after you have transferred the balances.

Loan consolidation helps you to manage your debts but it isn’t a cure-all. You will need to address the reasons why you got into debt. Creating an accurate budget, examining your spending habits and seeking free financial advice will help you improve your financial health

How to consolidate your loans

  • Make a list of all your outstanding debts, including the lenders, the amount owing, the interest rates and the loan terms where applicable
  • Use a loan consolidation calculator to compare loans from various lenders
  • Seek financial advice
  • Submit your application
  • Begin working on improving your finances

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