A debt consolidation loan helps you in consolidating your multiple unsecured debts into one easy payment loan. You repay the new loan through single monthly payments.
How can a debt consolidation loan benefit you?
- Multiple monthly payments can be replaced with a single affordable payment
- Lower interest rates than credit cards and can eliminate collection calls
- May opt for a long-term loan to reduce the monthly payable amount
- Budgeting gets easier as you need to manage only a single payment
- May have a positive impact on credit score
When is a debt consolidation loan a good idea?
- When you cannot stay current on your bill payments
- When you want to replace multiple bills by one single monthly payment
- When you find it difficult to manage multiple accounts and several creditors
- When you want to save money after making monthly payments
- Have good credit record and income
- Wish to get rid of troubled accounts through a lump sum payment
Debt consolidation loan eligibility - What is the criteria?
You need to qualify the following debt consolidation loan eligibility criteria:
- You should have a good credit score
- You need to have a source of monthly income
- Existing dues should not be too low
Is there only one type of debt consolidation loan?
No, there are 2 types of debt consolidation loans
- 1 Secured loans - These are home equity loans or lines of credit which you can take out keeping your primary or vacation home as the collateral. Such a loan can help you repay your debts with a large payment. But you need to have a good credit history and income potential to qualify for an equity loan or line of credit. Make sure you control your spending and save enough to make your loan payments on time. Otherwise, if you default on the equity loan, you may risk losing your home in a foreclosure.
- 2 Unsecured loans - This is an option using which you can repay multiple bills (credit cards, payday loans, student loans, etc.) with a single lump sum payment. You can also opt for utility bill consolidation by taking out such a consolidation loan. A personal debt consolidation loan requires low monthly payments in comparison to what you pay on your bills.
What do you need to do before applying for such a loan?
Calculate the balance amount
Check your credit report
Identify types of bills
Plan a budget
How can you take out the right and affordable debt consolidation loan?
Here are a few criteria that you should meet before you search for a debt consolidation loan.
- Your debt history:
Lenders will assess your past debts and their respective payment histories to get an idea about your debt habits and activities. They look for someone, whose past debt record is clean. You might argue that the reason for taking out a consolidation loan is that you’re in debt, then why should the lenders check your debt status!
Because the lender wants to be sure that you have the interest and capability to pay off your debts, instead of escaping from the debt obligations and responsibilities.
If the lender sees that you never tried to make a single timely payment, on your previous debts, in spite of having a sufficient moderate income, then you can be pretty sure to suffer rejections for your debt consolidation loan you plan to apply for.
Therefore, if your debt history is not upto the mark, then there might be a good deal of difficulties for you to get approved for a consolidation loan.
- Your credit score:
This may not be the primary concern for the lender, as those who apply for debt consolidation loans, usually have poor to average credit scores.
But yes it definitely matters! If you are having a very poor credit score, then getting a loan will be a bit tough.
Moreover, a relatively good score can help you take out a loan at favorable terms and conditions.
- The loan amount:
Lastly, it also depends on how much debt you have, as you will be obtaining a loan of an amount equal to the total debt balance you have. Suppose you want to take out a consolidation loan, of a huge amount, like more than $30k, or so, then the lenders will be very strict with the terms and conditions.
They might even want to keep a collateral for this loan, as there is a question of security. Your home equity can get attached as a collateral, or your car, or any physical property, that you own.
But, here is one suggestion.
If you are taking out a secured debt consolidation loan, then it’s better that you drop this idea, and instead, take out a Home Equity Loan or open a Home Equity Line Of Credit (HELOC). Doing so, you might get a better rate of interest on the loan.
What is the cost associated with a consolidation loan?
You may have to pay a fee to take out a personal/consolidation loan. Also, you should shop around and take out a loan from a financial institution, which charges relatively low-interest.
Where can you get debt consolidation loans?
- Credit union
- Online lenders
- Financial institutions
- Peer-to-peer lending websites
- Your home equity
What are the disadvantages of debt consolidation loans?
- When you pay off several bills with a large amount of consolidation loan that charges a low rate of interest, your monthly obligations become easily manageable. But the long repayment period of the loan makes you pay much more in total interest over the life of the loan.
- These loans do not provide you with any tax benefit; interest on a personal loan is not tax deductible
So, are debt consolidation loans bad? It can be said that it depends on you how you’re managing the loan. When you’re taking out such a loan, make sure that you can manage it properly and pay it back within the stipulated period.
How do debt consolidation loans work?
Have a look at these 5 simple steps to know how debt consolidation loans work.
Check your credit score:
Have a look at your present credit score to understand your creditworthiness.
Shop around for a loan:
Look for lenders who are willing to give you a consolidation loan based on your creditworthiness.
- 3 Apply for a loan: Read the terms and conditions of the loan. If you’re ready to accept them, then fill out the application forms and submit the necessary documents.
- 4 Pay off your debts: Repay your existing debts with the new consolidation loan. You can use such a loan to consolidate payday loans, credit cards, medical bills, storefront loans, along with other personal loans.
Make monthly payments:
Make easy and small monthly payments on the new loan till it’s paid off completely.
Are debt elimination loans the same thing?
The process of taking out a debt elimination loan is the same as a personal loan used for consolidation. However, a debt elimination loan is meant specifically for eliminating debt, and not used for other purposes. If you discuss the purpose of the loan with your lender before you take it out, then you get a reduction in the rate of interest.
Are debt consolidation loans good or bad for your credit score?
A debt consolidation loan can be both good and bad for your credit score depending on your situation.
It’s good for your credit score when:
- You can make monthly payments on time
- You can repay bills and reduce the credit utilization ratio
It’s bad for your credit score when:
- A hard inquiry is imposed on your credit report
- You keep on incurring fresh debts
- You can’t make monthly payments on the loan
So, to some extent, the pros and cons of using a debt consolidation loan depend on how you’re managing it.
What is the impact of a debt consolidation loan on your credit score?
Usually, debt consolidation loans don’t hurt your credit score since you repay bills in full. Lenders are happy to receive full payments. However, when you apply for a fast debt consolidation loan, it will be a hard inquiry on your credit report. But, it’s impact won’t be much on your credit report and score.
How can you get a debt consolidation loan without collateral?
You can use an unsecured debt consolidation loan calculator to compare the costs of your existing debts like credit cards, medical bills, current personal loans, private student loans, etc. with that of your new low interest easy consolidation loan. It will help you decide and take out the most suitable and affordable consolidation loan. You can use such a calculator to compute how long it’ll take to repay your new consolidation loan by paying a definite amount every month.
What credit score do you need to qualify for a loan?
You need to have a credit score between 630 and 640 to qualify for a consolidation loan. This is the minimum requirement. If your FICO score is below 600, you can still be eligible for a loan. But in this scenario, be prepared to pay high origination fees and interest rates.
Best debt consolidation loans demand a credit score of 700 or above. If you have a high credit score, then you may qualify for a loan at a 5.99% interest rate.
If you have bad credit, then consider secured easy debt consolidation loans. Lenders may agree to issue a loan, when you can pledge a collateral against it. Calculate the fair market value of the collateral. It should be worth the loan amount.
Are debt consolidation loans taxable?
Unfortunately, you won’t get any tax benefit for consolidating your high-interest bills with a debt consolidation loan. Many debtors take out home equity loans for consolidating their high-interest bills due to 2 reasons. First, the interest rate on a home equity loan is lower than credit cards. The interest rate on a home equity loan varies between 3.79% and 11.99%. Secondly, home equity loan interest is tax-deductible. So people can save both ways. However, one law has been changed recently.
Under the new law, borrowers can’t claim tax deductions for home equity loans and lines of credit anymore.
In case of unsecured debt consolidation loans, you can’t claim tax deductions for the interest paid to the lender.
What are the alternatives to unsecured loan consolidation?
Well, instead of opting for an unsecured loan for debt consolidation, you can opt for other consolidation methods too.
Enroll in a consolidation program: You just have to make a monthly payment to the consolidation company and it will negotiate with your creditors to reduce interest rates, and disburse your payments to the creditors on your behalf.
Opt for balance transfer method: You can transfer your existing balance from other credit cards to a card with a lower interest rate, and repay the amount within a specified period.
However, if you can’t pay your bills in full, then you can opt for debt settlement. Doing so, you can get rid of your debts by paying less than what you owe.
3 Things to know before you apply for a debt consolidation loan
1. Documents or paperwork is needed:
Usually the lenders require the following documents.
- your employment letter
- letters from your different creditors or repayment agencies
- Your recent credit card statements
However, depending on your credit history each lender might require different documentation.
2.Bank offers less interest rate on secured loans:
If you have several unsecured debts you should combine them and convert that into a secured debt. Banks set lower interest rate on a secured loan.This is because, if you fail to repay the loan amount, they can get the money back by simply selling off the security you have deposited against the loan amount.
Go for the loan that would help you in paying off your debts within three years.
Can I use the loan taken out for debt consolidation for any other expense?
The preferability of secured or unsecured loan totally depends upon your financial situation. A secured loan will have low interest rates and will help you to pay off the loan within your monthly budget. At the same time, if you're not able to pay off your installments then your collateral will be seized.
On the other hand, unsecured loan involves a longer repayment plan and you end up paying high interest rate. Unsecured loan is quickly available by the lenders. There is no risk of losing your house or any other asset if you take out an unsecured loan.
Do I need to own a house to consolidate my debt?
It is not necessary to own a house to consolidate your debt. An unsecured loan is available if you do not own a house or any other asset.
Why is unsecured consolidation loan so popular?
- The biggest advantage of unsecured consolidation loan is that it doesn’t require collateral, i.e. you wouldn’t lose your home if you fail to comply with the loan terms.
- Getting an unsecured consolidation loan is easier since it involves less paper work. It also takes lesser time to process the loan as no collateral is involved.
- Another advantage with it is that you can include the unsecured loan under bankruptcy when you default and can still save your house since a collateral is not required here. But when you file a bankruptcy with a secured loan included in it, you may end up losing your home.
But the picture isn’t all that rosy
Yes, the unsecured debt consolidation loan has its share of negatives too.
- Since there is no requirement of collateral, the rate of interest on an unsecured loan is higher than secured debt consolidation loans.
- If you have excellent credit score, you might not face any difficulties in getting an unsecured consolidation loan. But for people with average and poor score, it might not really be an option.
What is the maximum time limit within which I can repay my loans?
This completely depends on you and the creditor. Your monthly income and the amount of repayment per month are the key factors in deciding about the time limit. Also, how much time the creditor gives you is important. Mostly the time frame is 3-5 yrs.