If you have lots of different debts and you find that you are struggling to keep up with the repayments, then you are able to join them together into just one loan that will lower your monthly repayments.
In essence, you will borrow enough money so that you are able to pay off all your current debts and just owe money to the one lender that will only have one interest rate.
You are able to get a secured debt consolidation loan, which is where the amount that you borrow is against an asset like your home. This would mean that if you are not able to pay the loan back then you will risk losing your home.
An unsecured debt consolidation loan is where the amount that you borrow is not secured against an asset.
How Does a Debt Consolidation Loan Work?
A debt consolidation loan will need you to live modestly and you will have to exercise a great deal of discipline.
The amount that you owe doesn’t change with a debt consolidation loan, it is just able to pay off the debts you have with a new loan that you will need to pay back.
You are then replacing a number of loans with just one loan, that will hopefully have a better interest rate and monthly repayments.
Before, you choose to take a debt consolidation loan, you should look at your ability to repay the loan. You will need to determine how much you can afford to put towards it every month and if you will be paying a secured or an unsecured debt. Debt consolidation loans are generally geared towards unsecured debts like medical bills, credit cards etc.
You might be wondering if there are different types…
Types of Debt Consolidation Loans
Home Equity Loans
This is a loan that is taken out using the equity in your home as collateral. You will need to have a fair amount of equity in your home as well as good credit in order to get this type of loan.
The interest rates on a home equity loan are lower than other types of loans, but the problem is that your home will now be at risk if you can’t afford to pay the loan back.
Credit Card Balance Transfers
A balance transfer involves transferring credit card balances to one credit card that has a lower interest rate. You will find low balance transfer interest rates, which are promotional rates that will come to an end after a certain period of time. If you do choose to transfer your balances then you need to know when the special low rate ends and the normal interest rates come into being.
If you want to use a credit card balance transfer for debt consolidation then the credit card will need to have a large enough credit limit that is able to hold all of your credit card debt.
The problem with this is that your credit score will take a hit and will cause a negative effect.
You are able to use a personal loan for debt consolidation if you are able to borrow a large enough amount. A personal loan is an unsecured loan that offers fixed payments over a fixed payment term.
Once, you have been approved for a personal loan, you can use it to consolidate your debts. However, if you have a bad credit rating then you will find it difficult to get approved for a personal loan or may have a high interest rate.
Debt Consolidation Loans
You are able to get a debt consolidation loan, which is for the purpose of consolidating your debt. You are able to get this type of loan from a bank and other financial institutions.
A debt consolidation loan will ideally have a lower interest rate than the rates that you are currently paying on all your debts, but be aware that the lower monthly repayments might be because the repayment period is for longer, so you will be in debt for a longer period of time.
Wait…There are few things that you still need to know…
How Does Debt Consolidation Affect My Credit?
You have the opportunity to improve your credit with a debt consolidation loan as long as you use it as a financial plan and not just as a way to shift your debt around.
Once, you have taken out your consolidated loan, you will have paid your multiple debts in full and you can just focus on paying the new single loan.
If you are taking out a debt consolidation loan then we can assume that your credit has taken a hit. Your credit score will not immediately improve and may first take a dip, but once, you start making timely payments on the new loan then you will be creating a positive effect on your credit rating and over time it will improve.
Advantages and Disadvantages of Debt Consolidation
Advantages of Debt Consolidation
With a debt consolidation loan, you will have lower monthly repayments as you are spreading the loan over a longer period of time.
There is also a lower interest rate associated with a debt consolidation loan, so you will have a lower cost of debt overall.
As there are lower repayments, the debt becomes easier to manage. Also, by placing all your debt into one loan, you won’t have to try and juggle multiple payments with different payment amounts, due dates and interest rates.
Disadvantages of Debt Consolidation
If you have secured your debt with a home equity loan or mortgage then you will be risking your home if you fall behind on your payments.
As a debt consolidation loan extends your debt over a longer period of time, your cost of debt will increase.
If you have a bad credit score, then you may need to seek the help of a co-signer in order to get the loan.
Debt consolidation loans shouldn’t be rushed into and you should consider all of your options first. A debt consolidation loan can help if you find you are way in over your head as you will find it a lot easier to pay just one single loan with a lower monthly repayment and a lower interest rate.