Debt consolidation loans help you repay bills and satisfy creditors all at once. These loans are available at low interest rates. So, they don't create severe pressure and stress upon you. Check out these topics to know how consolidation loans work and help to solve your real life financial problems.
- Debt consolidation loan - What it is and how you can repay bills
- When it does make sense to take out a consolidation loan
- Types of debt consolidation loans explained
- How you can get a loan at low interest rate
- Unsecured debt consolidation loans - Pros and cons
- 4 Things you need to consider before taking out a loan
Debt consolidation loan - What it is and how you can repay bills
Debt consolidation loan works in a very simple way. This is a new loan which helps you pay off your current high interest debts at low cost. You're left with only one monthly payment after you've borrowed enough money to satisfy your existing creditors. The monthly payment amount for the consolidation loan is usually low and this helps you have a better control over your finances.
For instance, Sally has 3 credit cards and her total balance is $15,000. Sally takes out a consolidation loan of 17,000 and pays off her debt. She uses the remaining amount ($2000) for other purposes.
Previously, Sally had 3 credit cards but now she has only one loan. All she has to do is make a single monthly payment on the loan till it is completely paid off.
When it does make sense to take out a consolidation loan
It is ideal to obtain a loan under the following circumstances.
- You're unable to manage high interest rates loans
- You wish to have a better control over money
- You tend to forget the payment dates frequently
- You want to spend less on your monthly expenses
- You want to have more money after paying back your creditors
- You want to pay unsecured debts such as credit card bills and student loans
Types of debt consolidation loans explained
Debt consolidation loans are available in 2 forms - secured and unsecured.
- Secured debt consolidation loan - The lender gives you a loan on the condition that he can seize a particular asset that you've used as collateral in the event of loan default. This asset can be anything – car or a house. The most common form of a secured loan is a home equity loan wherein you obtain a loan against the equity of your house. The interest rate on the loan is really very low since it is secured by the equity in your home. Home equity loans are very inexpensive as the interest rates are tax deductible. However, the biggest problem with these loans is that you'll lose your property if you can't pay them off within the specified time period.
- Unsecured debt consolidation loan - This is more popular amongst the people since they don't have to pledge security against the loan. The interest rate on this loan is comparatively higher than that of the secured loan. The most common form of a unsecured consolidation loan is a personal loan.
How you can get a loan at low interest rate
You can qualify for a consolidation loan at low interest rate in the following ways:
- Opt for a secured loan: The interest rate on this loan is typically low as the lender has less risk. He can get back his money be selling off the property in the event of loan default.
- Have a decent credit score: The lenders are likely to charge less provided you've a decent credit score. If your credit is tarnished, then try to opt for a secured loan. You'll have to pay a higher rate of interest on an unsecured loan because of greater risk.
- Borrow from friends or relatives: You can consolidate your bills with a personal loan. You can request your affluent friends and relatives to give you a loan at zero or low interest rate.
- Have a regular source of income: You must have a good income so as to obtain a loan at low rate. Lenders would want to be sure about your capability to pay off the loan along with your other bills.
Unsecured debt consolidation loans - Pros and cons
An unsecured debt consolidation loan offers certain benefits such as reduced collection calls and lower interest rates. However, these loans have a few drawbacks too. For instance, longer repayment terms.
Check out the pros and cons of these loans before submitting your application form.
- Pay back your creditors instantly: You can pay off the outstanding balance on the unsecured bills at once. You'll just have to pay a small amount on the new loan every month.
- Get less collection calls: You'll get less collection calls after repaying the bills with the new loan. You can reduce the stress of dealing with multiple creditors at the same time.
- Pay less and save money: The consolidation loans are available at lower interests than that of the credit cards. So, you'll have to pay less in every month. You can finally afford to save money.
- Find it easier to follow a budget: Once you replace your several bills with only a single loan, it becomes easier for you to create and follow a budget.
Finally, after you've repaid your loans comfortably, you can start working on your damaged credit. You can start taking steps to improve your credit gradually.
- Longer repayment term: Usually, unsecured loans come with longer repayment terms. Your monthly payments will be significantly low but you'll pay a lot more in the long run. You'll eventually pay a huge amount in total interest.
- No tax deduction: You won't enjoy any tax benefits on the unsecured consolidation loans. You can't claim any deduction for the personal loans.
4 Things you need to consider before taking out a loan
Check out the 4 things that you've to consider before taking out a loan from a lender.
- Interest rate: Calculate the interest rate on the new loan before signing a written agreement. It will be very difficult to change the rate after you've put down your signature on the written agreement. Shop around to obtain aloan at the best rate. Make sure you don't take out any loan wherein the interest rate is low for only a short period of time.
- Repayment term: This is very important for if the repayment term is too long, then debt consolidation won't be a good option for you. There's no doubt that your interest rate will be low. However, you'll eventually pay off this loan after 20 years. You'll be in debt for a very long period of time.
Try to obtain a loan that has a short repayment term and lower interest rate. You may have to wait for a few months to obtain a loan that suits your financial needs. However, the wait will be worth it.
- Risks involved: You've the risk of losing your home in case of a secured loan. If you default on the loan, then the lender may seize the property and sell it off in order to recover the loan. Moreover, if you decide to sell your house, then you'll have to repay the home equity loan first.
- Your credit score: Check out your credit score before applying for a debt consolidation loan. A good credit score will enable you to have a loan at low interest rate. However, if your score is too low, then you'll have to pay a high rate of interest.
Clearly, low rate consolidation loans can help pay off your debts through a single and affordable payment plan. However, if you're unable to obtain a suitable loan, then review your budget and try for a consolidation program instead.