Debt consolidation is the process of taking out a new loan and paying off existing debts with it. Debt consolidation loans are generally advised to those who have multiple unsecured loans to pay off. These loans can be multiple credit cards, personal loans or some borrowing from private money lenders. Going for a debt consolidation loan is mostly helpful to reduce your monthly payment amount by reducing the interest rate.
The idea behind debt consolidation
A debt consolidation loan basically gathers all your existing unsecured loan debts into one loan. This can be done by availing of a new personal loan at a lower interest rate while setting up a manageable monthly fee paid over a set time. This allows consumers to pay less interest and potentially get out of debt more in a comparatively lesser time.
- A debt consolidation loan helps you reduce the interest.
- Shorten the time needed to become debt-free.
- You pay only one EMI.
Options to consolidate your debt
There are only a few options that lead to debt consolidation. However, all have a few positives and negatives.
- Taking a home equity loan
- Taking a secured line of credit/ home equity line of credit
- Going for a balance transfer with a new lender
- moving your debt to a single low-interest personal loan
However, among all taking an unsecured personal loan and paying existing debts is the most common one.
Pros & cons of debt consolidation.
Pros of consolidating your debt
Though debt consolidation is an effective measure, it can be useful without proper planning. However, in the best-case scenario the pros associated with debt consolidation are:
- Makes debt manageable for you: Going for debt consolidation is a proven way to reduce your financial stress. Actively making a plan to fix the pitfalls of your finances and consolidating your existing debt makes your loans manageable to a great extent.
- Gives you peace of Mind: As consolidating the debts reduces your financial stress, it gives you some peace of mind and reduces the stress of managing multiple payments.
- Reduces interest rate: The main reason to go for debt consolidation is to reduce the total payable EMI amount. And this is achieved by taking a loan at a comparatively lower rate of interest. This saves you a lot of money which you would have previously paid towards interest.
- Improve your credit score: Taking a debt consolidation loan Reduce your credit utilization ratio which ultimately increases your credit score. By paying off multiple debts through consolidation, you will improve your credit utilization score by using less of your available credit, and therefore possibly your credit score, more quickly.
Cons of debt consolidation
- Can Increase your Debt: If a debt consolidation loan is not taken with proper planning and research it can also affect your finances negatively. This can happen only when you are not able to manage your new loan properly. To make everything fall in place, you need to plan repayment of your new loan even before you opt for it.
- You may not be able to save more: Though debt consolidation loans are taken to save money which is going towards debts. But you can not trust and go for any debt consolidation loan blindly. To make sure you save more- research well, compare among all the available options, calculate the total borrowing cost by using an EMI calculator. As even going for a low-interest rate and consume the same amount of money in the loan run.
- Pre-payment fees can add to your total expenses: Taking a debt consolidation loan closes your existing loans. This means you may need to pay pre-closure free to your existing lenders. This can spoil your enjoyment, as paying this will be added to the total expense towards consolidating the debt. Hence it becomes important to check for the pre-closure free with your existing lenders. if it is more, it is better to keep the loan going with the same lender. But don’t come to any conclusion before calculating everything.
Remember with debt consolidation, you get a single loan to pay off all of your smaller loans/unsecured loans. The process is quite helpful and reduces your financial stress, however, before you come to any conclusion it is important to know the pros and cons.