Debt consolidation loans are a popular financial product that people use to reduce their debt burden. But whether or not it is suitable depends on your circumstances, the type of debt, and the specifics of the consolidation.
Multiple debts create debt fatigue, meaning most of your income is used to pay instalments.
Let’s try to understand what debt consolidation is and its advantages. And drawbacks. Learn whether It can be the best solution. Also, know where it may not be the relevant trouble-shooter.
First of all, let’s know.
What is debt consolidation?
Debt consolidation is converting multiple debts into a single loan or debt. It means that a single loan is paid off by combining the existing debts into one loan.
After borrowing a larger loan amount equivalent to multiple debts, you pay off all the debt.
This amount is equal to the amount of your multiple debts. With this, you pay off all your loans. After that, you have to pay only one instalment of the debt consolidation loan you took.
Its primary purpose is also that you pay the applications at a lower rate of interest. Debt consolidation can be done in various ways, such as by taking personal loans, balance transfer of credit cards, home equity loans or lines of credit. Besides this, debt management plans or debt settlements.
Pros of debt consolidation
For some specific reasons, this loan product is widely prevalent among borrowers. Let us understand its pros.
Let us look at the benefits of debt consolidation loans.
Simplified payments – The first benefit is simplified payments. The first benefit of debt consolidation is that your repayments become very simple. Where earlier you were paying multiple instalments of multiple loans.
Now, you have a single instalment of just one loan with different payment due dates. Instead of struggling to manage the due dates, you will have to take care of just one due date.
Similarly, earlier, you struggled to manage the interest rate on each loan. Now you have to manage the interest rate of just one loan.
Lower rate of interest – The second most significant advantage of debt consolidation loans is that you can enjoy lower interest rates. This reduces the size of your monthly instalment. By paying smaller instalments, you can save more money. This helps you manage your budget and expenses. You can use this money for investing and considering savings.
Pay fixed instalments – The third advantage is that each loan has a fixed monthly payment. Since the consolidation loan has a fixed interest rate, it gives you predictable repayments. Earlier, when you were paying instalments at different interest rates through different loans, you now have to pay one at a fixed rate.
No matter how volatile the market is, you can easily pay only one specific amount in the form of instalments due to the fixed interest rate. That is why debt consolidation is considered a profitable financial product.
Improve your credit score – Its fourth advantage is improvement in credit score. Mostly, consolidation is done when you are a victim of multiple obligations. Due to this, you are not able to pay your loan on time. At the same time, your credit rating goes down, but with the help of debt consolidation, the debt on you is reduced. This directly affects your credit score.
When you pay the instalment on time, it increases your credit rating rapidly. The amount you borrow through a debt consolidation loan is used to pay off all your other multiple loans. Also, it becomes easier for you to pay the instalment of the debt consolidation loan. With every timely repayment, your credit score improves.
Pay off debts in a short time – The advantage is that you can pay off your debts quickly. Everyone wants to get off their debts early, but it is impossible due to multiple obligations. Thanks to debt consolidation loans, you can reduce your debt size and quickly get rid of the application by paying off your debts as soon as possible.
Cons of debt consolidation
There are two sides to it. Similarly, there are pros and cons of debt consolidation loans, too. Let us know its disadvantages.
Higher total cost of loan – The first disadvantage is the higher overall cost. The possibility of a debt consolidation loan can reduce the interest rate charged on your debt. Still, if it increases the tenure of your loan, then you are paying a higher interest rate.
For example, if your loan tenure is five to 10 years, you pay a significant interest rate over such a long period. Some consolidation loans may also have prepayment penalties or origination fees, which increases the overall cost.
Debt accumulation – The second disadvantage is the accumulation of more debt. It indeed makes it easier to manage your multiple debts. But if you start indulging in irresponsible financial behaviour, the risk of a debt cycle is there. For example, you have consolidated your credit card debts in consolidation. But if you start using your credit card again, then there are chances of a debt cycle on you. It has a bad impact on your credit score.
Impact on credit score – If you cannot pay the repayments on time, see a direct impact on your credit rating. With every delayed or skipped instalment, your credit rating will go down.
Not only this, it also affects the debt-to-income ratio. Besides, consolidating your debts, such as credit card debt in the form of balance transfer, can lead to a fall in your credit rating.
Need a good credit score for best rates – Its fourth disadvantage is that you need a good credit rating for debt consolidation. However, a consolidation loan can be availed even in a bad credit situation. But to get the best rate of interest, it is essential to have a good credit rating. If your credit score is poor, you will get the loan but better rates will not be available. Also, due to the longer tenure, you may have to pay the overall cost.
Is debt consolidation worth it?
After reading the information above, knowing whether debt consolidation is useful will be easier. It depends on your specific financial circumstances.
The first factor in this is your total debt. If the amount of your total debt is such that you are finding it difficult to pay multiple installments, then debt consolidation loans are helpful. If you are able to pay your installments easily, then you can opt for debt consolidation.
The second factor is the interest rate and terms. If, after debt consolidation, you get to pay a lower interest rate, it is fruitful for you. Then, it comes to your financial habits. A debt consolidation loan is taken to reduce your debt burden. If you are committed to paying your loan instalments on time, you must consider a debt consolidation loan.
The third factor is the type of debt – Debt consolidation loans are mostly more useful than credit cards or unsecured loans for high-interest debts. Depending on your type of debt, you can decide the significance of this loan solution.
The fourth factor is credit score impact. With the help of a debt consolidation loan, you can improve your credit rate in the long run. But not paying on time leaves a negative impact. Therefore, make timely payments. You get better deals on all financial products when your credit score improves.
Conclusion
Now you can understand the worth of debt consolidation. This financial product is quite helpful. As per your financial circumstances, you can use it for your purposes. No loan solution is ever useless. It is only your conditions that this loan product may or may not suit.
