Debt Consolidation: Things You Need to Know Before Consolidating Your Debt

Debt Consolidation: Things You Need to Know Before Consolidating Your Debt

This article provides a clear picture regarding debt consolidation. Clarify all your doubts related to this term. Make yourself fully aware before taking any decision. In case you’ve missed anything, go through this article.

What is Debt Consolidation?

When you take a new loan to pay off your existing loans and liabilities, that is known as debt consolidation. It allows borrowers to pay off a small loan in one go by taking a big loan. Multiple debts are combined into one debt along with more favorable terms such as lower interest rate, lower monthly payment, etc. Here the new amount is used to pay off old small debts. Usually, people go for debt consolidation to repay student loans, credit card loans, etc. By consolidating their debts, borrowers save on interest as well as the small loan’s finance costs. It is indeed a sustainable option.

How does the Process work?

Debt consolidation is the process of using different financing techniques to settle other liabilities. If a customer is burdened with multiple small debts, he can apply for debt consolidation and repay them back as a whole. Payments are then made on the new debt until it is settled in full. Most people contact their bank, credit union, or their card company for this purpose. However, it is the best way to start. The institutions even approve the user’s application if they have good relations with them. In case, the user is turned down, he can contact private mortgage companies or lenders. They will help them out.

Types of Debt Consolidation

Mainly, there are two types of debt consolidation loans:

  1. Secured loans- Usually, secured loans are backed by one of the assets of the borrower. For example- jewelry, a house, or even a car. The asset acts as security for the loan. The lender holds the asset until the debt is paid back in full. A secured loan is the most common way to borrow a large sum of money. House loans and mortgages are the most common examples of secured loans. It can also include stocks, bonds, and other personal property.
  2. Unsecured loans- These are very different from secured loans. Unsecured loans are not protected by any collateral or security. Lenders observe the borrower’s credit score before providing them an unsecured loan. Since this loan isn’t protected by any collateral, it has high-interest rates. For example- student loans, home loans. In case the borrower isn’t able to repay the loan, the lender can’t take over the property. These loans are becoming quite popular nowadays.

Ways to Consolidate Your Debt

There are several ways to consolidate different debts into one. Some of them are given below.

#1 Debt Consolidation Loans

Traditional banks and other financial institutions, including peer-to-peer lenders, offer debt consolidation loans to borrowers. It is specially provided to those debtors who are facing difficulties in repaying several outstanding debts. This way is recommended to those people who want to settle multiple, high-interest-rate loans.

#2 Credit Cards

Another way to consolidate your debts is by getting a new credit card. You can apply for a credit card and repay your small liabilities. There are several credit cards available that charge very little or no interest rates for a particular time period. Some credit cards also offer a transfer feature. You can avail of that feature to transfer your existing credit card balance into the new one.

#3 Home Equity Lines of Credit

HELOC or Home equity lines of credit is another way of debt consolidation. In this method, the lender gives the borrower a particular sum of money, in return for the borrower’s home equity as collateral.

Advantages of Debt Consolidation

Debt consolidation is the best option for people with multiple debts. They can merge all their debts into one and settle them as a single liability. It is also good for high-interest rates and high monthly payments. Consolidation also helps in improving customer’s creditability. It can also help in securing a lower interest rate over the course of time. Consolidating all your debts is also good for your mental health. Getting relieved from all sorts of debts is a stress buster.

Disadvantages of Debt Consolidation

Besides several advantages, debt consolidation has some disadvantages as well. Though it lowers the interest rates, you need to pay attention to the payment schedule as well. One must keep in mind that getting a debt consolidation will guarantee no more debts in the future. If you don’t plan a budget, you will land into new liabilities. Moreover, it may come with extra expenses. Applying for debt consolidation may include origination fees, balance transfer fees, closing costs, and annual fees.

Debt Settlement and Debt Consolidation are Two Different Things

Some people think that consolidation and settlement are similar terms. But that is not the case. One must be aware of the fact that debt consolidation doesn’t erase the original liability. Instead, it transfers the original loan to another lender or a new type of loan. Debt settlement focuses on lessening the customer’s responsibilities rather than the number of creditors. There are various debt relief organizations or credit counseling services available. Consumers can contact them if necessary.

Things to Note While Planning for Debt Consolidation

Customers need to keep a few things in mind while planning debt consolidation.

  1. Identify your debt obligations
  2. Make sure you know the total payable amount to the lenders
  3. The time period or the tenure
  4. Apply for debt consolidation via an authentic institution
  5. Once approved, pay off all the debts as soon as possible

Requirements for Debt Consolidation

In order to get the consolidation approved, borrowers must have the necessary income and creditworthiness. Try to contact a known lender. If they turn you down, then only go to a new lender. There are certain documents that you need to present before the lender. For example- letters of employment, credit card statements, letters from creditors, etc. When your consolidation gets approved, pay off the high-interest debts first. Then go for the lower ones. You can also pay off at your convenience.