HOW DOES A DEBT CONSOLIDATION LOAN WORK?

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Debt consolidation entails taking out a new loan to pay off a number of liabilities and unsecured debts, by combining them into a lump sum with more favourable payoff terms, such as a lower interest rate or monthly payment. Debt consolidation can be used to pay off payday loans, student loan debt or credit card debt, wherein the aim is to make the process of repayment easy for the borrower. This option appears especially lucrative for those who have acquired payday loans with bad credit, however, one should have the capacity to pay back the debt in full whenever the payments are due. It is important to remember that you are essentially repaying a larger amount over a longer period of time.

Securing Collateral

A debt consolidation loan lender will often opt to use a secured loan against larger loans associated with a collateral – a personal asset, such as a house or an automobile. The interest rates on an unsecured loan are likely to be much higher in most cases. Having a secured loan in place would place your collateral at risk if you fail to make the repayments on time.

Debt Consolidation – Benefits

Acquiring a debt consolidation loan can have the following benefits if managed in a proper manner:

Improvement in Credit Score: If you do not accumulate further debt post acquiring debt consolidation and manage to pay it off, you will witness a gradual improvement in your credit rating which will make lenders view you in favourable light. It is advisable to go through your credit score report thoroughly before applying for fresh loans.

Reduction in Monthly Payments: You will be essentially spreading out the term of the debt when you avail a debt consolidation loan. When this happens, your monthly repayments will reduce considerably, allowing you to manage your finances in better ways. In most cases, individuals have to shell out the minimum payment that is allowed on existing debt. Typically, this means that the interest rate applicable on the said loan is covered, whilst the total amount remains unchanged.

Reduction in Interest Rates: If you have accumulated debt on a credit card that levies a high-interest rate, you can pay back with lesser rates with the help of a debt consolidation loan.

When looking to grant a debt consolidation loan, a lender assesses your outstanding debt, along with your credit risk to determine whether you are eligible for the loan process. Having an unfavourable credit history or large amounts of outstanding debt might cause a lender to offer you a secured loan. This entails loan security in the form of a collateral, which is liable to be taken away in the event that you are unable to pay the amount back. Thus, if you have a bad credit score or an immense debt, be sure that you will be able to cope with the loan to avoid losing your secured collateral.

On the other hand, if your outstanding debt is manageable and your credit rating is alright, you are in an advantageous position in terms of availing a debt consolidation loan. One can also use personal loans to consolidate debts, wherein the lender will look at the following factors:

  • Your credit history
  • The overall amount you wish to borrow from the lender
  • The duration of time you will require to repay the debt

Understanding the Fees Involved

A debt consolidation loan comes with fees – hence, in addition to your current outstanding debts, you can expect added fees on top. There are many charities that help with debt consolidation, as they do not charge fees for managing your debt. This is a viable option for individuals looking for help – one can also hire a professional to contact every creditor you owe and take care of the process for you.

Remember, debt consolidation alone cannot get you out of debt, improving your spending habits can. Consolidation is only a tool to help you escape the horror-house of debt: whether you make it or not is up to you.