Debt Consolidation Explained: An In-Depth Guide On Consolidating Your Debts

AdminBy AdminOct 28, 20170

Racking up piles of debt is never a pleasant experience. When you’re swamped with high-interest loans that disrupt your cash flow, you may feel helpless regarding your financial predicament. Debt consolidation offers a streamlined way to pay down your debts, so you can focus on your new loan instead of multiple, confusing bills. Nonetheless, this debt management strategy doesn’t come without caveats.

It’s crucial to assess your particular financial situation to determine if debt consolidation is the right solution for you. Read on to understand what debt consolidation means, the benefits it offers, the common pitfalls associated with consolidation loans, and the pros and cons of different consolidation options.

Debt Consolidation Explained

Debt Consolidation Explained

Debt consolidation merges all of your existing debts into one, new loan, making repayment convenient. A single monthly loan payment means you don’t have to go through the hassle of monitoring numerous bills, debt amounts, due dates, and interest rates. You can focus on the new loan and repay only one lender, making the process of paying down your debt easier.

Your new consolidation loan has different terms than your current financial obligations. Debtors usually take out consolidation loans to manage credit card debts, personal loans, student loans, and other debts without collateral.

Key Benefits Of Debt Consolidation

Key Benefits Of Debt Consolidation

The primary advantages of consolidating your debts include:

  • Low interest rate

    More often than not, credit card debts involve steep interest rates that soar up to 25 percent and above. High interest rates cause your debts to grow bigger and bigger until you’re knee-deep in financial troubles. A debt consolidation loan may give you a lower interest rate and/or lower monthly payment, potentially helping you save over the long haul.

  • Simple payment process

    If you’re like most debtors, you probably find it difficult to keep track of your loans, causing late or missed payments. Consolidation offers a streamlined repayment process, so you don’t have to stress yourself over numerous due dates. A single loan is much easier to handle than multiple credit card debts or loans.

  • Doesn’t affect your credit score negatively

    Compared to debt settlement which counts against your credit score, debt consolidation lets you pay off your entire financial commitments without negative effects to your credit report.

  • Less stress

    With only one monthly payment to focus on, you won’t have to dread corresponding with various creditors or opening the mailbox with piles of bills awaiting you. A consolidation loan may help ease your burden of being in debt and help you manage your finances more efficiently.​

Is Debt Consolidation A Smart Choice?

Is Debt Consolidation A Smart Choice?

Debt consolidation holds potential in helping you get out of debt, but it’s not a one-size-fits-all solution for debtors. While this payoff strategy enables you to make only one monthly payment to your chosen lender, remember that it’s a financial product, and many financial institutions wouldn’t offer debt consolidation if they didn’t profit from it.

There are lenders that genuinely help debtors manage debts as there are lenders that take advantage of unknowing borrowers.

Whether a consolidation loan can help improve your financial matters or not depends on your specific financial circumstances. Moreover, if you decide to use the services of a debt consolidation company, it’s important to choose a credible firm that charges reasonable fees.

Consider the following factors to evaluate if debt consolidation is possibly beneficial for you:

  • Too many outstanding debts

    If you have more financial commitments than you can handle and your creditors no longer allow you to negotiate lower interest rates, debt consolidation may help you gain more control over your finances.

    A consolidation loan may result in a considerably lower interest rate, helping you save on interest. The loan makes sense if most of your debts have high interest rates and monthly payments. If you have only a few small debts that you can probably manage with a good repayment plan and ample discipline, debt consolidation is likely not necessary.

  • Better savings in the long run

    Does your prospective consolidation loan actually help you save over time? If you’re considering a potential consolidation loan, compare its length to the time you need to pay off your present debts at your current payment rates. The loan is a good option if it leads to less costs in the long haul. However, you may not benefit from this repayment strategy if paying off your debts in a shorter period allows you to save more.

    Evaluate which option between paying off your financial obligations quickly and taking out a consolidation loan is less expensive, with interest rates and repayment periods considered. In some cases, it makes more sense to focus first on paying down your credit card debt with the highest interest rate than taking out a consolidation loan.

  • Monthly payments comparison

    Your potential consolidation loan’s new monthly payment should be lower compared to your existing monthly payments. However, keep in mind that even if your new monthly payment and interest rate are lower, you may end up paying more interest over time if your consolidation loan has a long-term, so it’s best to choose a shorter term.​

Different Ways To Consolidate Debts

Different Ways To Consolidate Debts

Debt consolidation loans are usually classified into secured and unsecured loans. Taking out a secured loan requires backing the loan with collateral, such as your home or car. If you fail to pay down your loan, your creditor forecloses your house or repossesses your vehicle to acquire payment for the loan.

In comparison, you may apply for an unsecured loan without using collateral to secure the loan, but this type of loan typically involves higher interest rates due to the lack of security for repayment.

Using A Secured Loan To Consolidate Your Debts

Numerous debt consolidation options are available when you opt for a secured loan. You can apply for a second mortgage, refinance your home, obtain a home equity line of credit, or use your car to get a car loan. Another option is to take out a 401(k) loan, which uses your retirement funds to secure the loan. Many financial institutions also offer secured loans against annuities, life insurance policies with cash value, and even lawsuit claims.

Pros



  • The primary advantage of consolidating your debts using a secured loan is that you have much higher chances of getting low interest rates, giving you a more affordable monthly payment. Additionally, it’s worth noting that interest payments are tax deductible sometimes, especially when you pay interest on a loan backed by real estate property. Because secured loans involve lesser risk for lenders, they are often easier to acquire than unsecured loans.

Cons



  • The major drawback to using a secured loan is that your pledged asset is on the line. Failure to pay back a secured loan means you could lose your home, vehicle, or other valuable property. Your asset is at stake, which is why it’s essential to make sure that you’re ready to take the risk and you’re actually capable of repaying the loan. Also, as mentioned earlier, you may end up with a more expensive overall interest payment if the term of your loan is longer compared to the term of your outstanding financial commitments.

Using An Unsecured Loan To Consolidate Your Debts

It’s often harder to qualify for an unsecured loan if you have a poor credit score. Financial institutions have more stringent requirements for obtaining unsecured loans, because these loans involve more risk for them.

Unfortunately, the people who need unsecured loans the most don’t have excellent credit scores. If you have a favorable credit score, you have better chances of getting a loan with a low interest rate.

An alternative to unsecured consolidation loans are zero-percent interest or low-interest credit card balance transfers, which are potentially beneficial if you’re capable of paying down your debts during the limited introductory period.

However, if you make a late payment or miss a payment, your creditor may immediately start charging interest, which can make your financial matters worse. If you’re struggling to reduce your spending, it may not be a good idea to use another credit card that lures you to spend more.

Pros



  • When you take out an unsecured loan, you don’t have to pledge any property to secure the loan. Your creditor cannot seize any of your possessions if you default on your loan. Nevertheless, it’s critical to repay your new loan on time so you can get back on track, improve your credit score, and avoid ensnaring yourself in another financial dilemma.

Cons



  • As pointed out, you’ll most likely find it difficult to qualify for an unsecured loan if you don’t have a favorable credit score. Another downside are the higher interest rates. If you choose to get a no-interest credit card and there are costly transfer fees, your potential savings may be nullified. Remember that the introductory period lasts for a limited time only, typically within six to 18 months, so it’s essential to repay your loan before the introductory period ends; else, you’ll end up paying higher interest.

Using A Debt Consolidation Company To Manage Your Debts

Using A Debt Consolidation Company To Manage Your Debts

When you obtain a loan from a debt consolidation company, you’ll pay one monthly payment to the firm, and the consolidation company will take care of your financial commitments. When going this route, it’s crucial to choose a legitimate company that offers reasonable rates and fees.

Also, many firms claim to provide consolidation services but actually perform debt settlement, which is a risky payoff method that can drastically affect your credit report if the company fails to pay your creditors properly.

Be sure to research the background, services, and customer reviews of a consolidation company, so you don’t fall into a worse financial crisis than you’re already into.

Some consolidation companies increase the interest rate if you miss a payment or make a late payment. Use these tips to repay your debts successfully using a debt consolidation company:​

  • Select a shorter loan term

    If possible, pay down your new loan in less than five years. The longer it takes to repay your loan, the more interest you’ll have to pay.

  • Check the contract thoroughly

    There shouldn’t be any hidden costs or fees, especially balance transfers and application fees. Ask your chosen lender if you need to clarify anything.Compare different financial institutions.

    Review the interest rates and fees offered by several lenders to make sure you’re getting the best deal. You may want to ask for recommendations from friends who tried using the services of a debt consolidation company before.

  • Be cautious of predatory lenders

    Steer clear of shady consolidation companies that lure you with exceedingly low rates and fees. Search online for consumer reviews to find out what other people saying.

Is Debt Consolidation Right For You?

Is Debt Consolidation Right For You?

Your financial situation and ability to control your spending are key factors that determine whether a consolidation loan may help with your financial hardship or not. To recap, here are the key points to consider to assess if debt consolidation makes sense:

  • You have more debts than you can handle, and most of these debts have high interest rates and monthly payments.

  • Your potential consolidation loan gives you a lower interest rate and a lower monthly payment, and it allows you to save more over time compared to paying down your previous debts.

  • You’re capable of reducing your spending and avoiding new debts.

If you’re planning to use debt consolidation only because it’s more convenient for you, this payoff tool may not be your best option. Try to consult a qualified, nonprofit credit counselor before anything else, so you can explore and weigh your choices properly. To succeed in getting out of debt, it’s essential to stop overspending and commit to your chosen repayment strategy.

Conclusion

Keep in mind that becoming debt-free involves plenty of discipline and motivation. If you amass more debts while paying off your current loan, you may get trapped in an unending debt cycle. Create a realistic budget every month, and build an emergency fund by setting aside a small portion of your income as often as you can.

To avoid the temptation of unnecessary purchases, stash away your credit cards and make it a habit to bring cash when shopping. With a sound repayment strategy and strict spending behavior, you’ll be on your way to enjoying a debt-free life.

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