Debt Consolidation

Darryl Bachmeier
Jul 28, 2020
Finance


Debt consolidation has the allure of simpler payment and lowers interest rates. You need to know what is debt consolidation and all the benefits and drawbacks it has before you consider consolidating. So, let’s talk about debt consolidation.

What is Debt Consolidation?

Debt consolidation is the act of taking a new loan to pay off existing debts and liabilities. It consolidates your outstanding balance from your current credit card or other financing methods. In other words, it combines multiple other debts into large debt, similar to a loan, and it generally has likable payoff terms, like a low monthly payment, low-interest rate, or a combination of both. You can use debt consolidation to pay off student loan debt, your credit card debt, and any other debts or liabilities you have. 

Most people who want to consolidate their debt apply through their respective bank, credit card company, or credit union. It’s a great first step and a great place to start because if you have a good history of payment and a good relationship with your institution then you can very easily consolidate your debts. However, if you get denied then you can try lenders or private mortgage corporations. 

There are several reasons for creditors to do this. Debt consolidation increases the chance of collecting from a debtor. Financial corporations like credit unions and banks usually offer these loans, however, there are specialized companies who also provide consolidation service to people. 

Key points that you should keep in mind

  • You can take a single loan so that you can pay off multiple other debts in debt consolidation.
  • You can apply for low-interest credit cards, debt consolidation loans, special student loan programs, and HELOCs.
  • You only have to pay a single monthly payment rather than multiple payments, and you also get lower interest rates.
  • You also need to remember that there are two types of debt consolidation; secured and unsecured.

Two types of debt consolidation

As we said before, there are generally two primary types of debt consolidation loans, and they are secured and unsecured loans.  Secured loans backed by one of the assets of the debtor, like a car or a house. The asset works as the collateral for the loan. On the other hand, unsecured loans are not backed by the debtor’s assets and it can be challenging to obtain as well. They also have low qualifying amounts and high-interest rates. No matter what type of loan you take, they still have lower interest rates than the rates charged on credit cards. Also, the rates are fixed in most cases, so the rates do not change over the repayment period. Now let’s talk about the pros and cons of debt consolidation.

Pros

  • You can potentially save money: People generally consolidate because it can potentially save them money. Debtors with robust credit can normally qualify for low-interest consolidation so that they can pay off higher interest debts, like credit cards. For example, if you qualify for an 8% APR personal loan and then use the loan to pay off credit cards with 18%-22% APR, then you will save money. If you want to be sure how much money you exactly save then you can calculate it yourself counting the fees and other things.  
  • You can easily pay bills: Debt consolidating makes it that you only have to pay a single monthly payment. When you have to factor in four or five different credit card payments each month with other payments then it becomes a major hassle each to pay them differently. That is why consolidating makes your bill payments easier so that you don’t have to pay multiple payments each month. It also makes your budgeting easier as well since you only have one same amount to pay each month.  
  • You can build your credit: If you make routine payments for a loan over some time it makes you more responsible in the eyes of your lenders, and in turn, it can boost your score. Also, don’t close your credit card accounts even after paying the balances off, so that you do not increase your credit card utilization, it can damage your credit score.

Cons

  • You could have more debt: If you take a personal loan it means you are borrowing more money. So, after you take a personal loan to pay off the credit cards and when you begin to carry a balance on the credit cards, then you are making more debt than before. Debt consolidation is not your one-way ticket to a debt eliminator; you need to use it only when you have exhausted other options.
  • Your assets are at risk: If you want to get low-interest rates then one significant way is to secure an asset of yours against the loan you take. You need to be very careful about not missing payments or defaulting because the bank or the lender can seize your asset.
  • You might take no more debt: A significant problem when you pay off your credit cards is that even if you have no loan, you can run the balances up again. If you avoid the temptation of taking more debt then you have to commit yourself to your budget and keep your spending habits in check during the loan repayment period.

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