Debt generally refers to money being owed by an individual, persons, businesses and governments. Debt consolidation refers to the act of taking out a new loan to pay off other liabilities and consumer debt.
Debt consolidation enables you to merge your debt into a sole loan. An individual who has a lot of debts to settle can consolidate such debts into one single debt by taking out a new loan to settle off other debts. This process is intended to reduce the number of loans an individual is paying off at once.
For instance, students can take many loans from financial institutions and banks to fund their education. Their expectation is to graduate and get paid employment then settle down to paying their student loans.
Secondly, people can take off medical loans as a result of terminal illnesses like cancer. Thus is finance wrecking disease. Most people incur large amounts of debts during this period as they are borrowing from different sources.
Instead of paying the different banks or other creditors monthly, they can obtain a bigger loan to pay for all of their debts. When this is done, they can now start paying off the new loan. Debt consolidation narrows down ones debt obligations to a single loan obligation. You enable the debtor to keep track of the payment plan, interest rates and maintaining them.
Ways Of Settling Debts
1) Debt settlement: This refers to a situation where a person’s debt is negotiated to a lesser interest rate with a view to reducing the overall burden. This is a clever way to get your creditor to reduce your debt.
2) Debt Relief: This refers to a situation where a part or whole of a debt is forgiven. This means that the creditor has written off the amount owed to him or her. The debtor is no longer mandated to pay such debts.Â
3) Debt consolidation: This means that a debtor has taken on a new loan to pay off old debts.
Why Must You Consolidate Your Debts?
Debt consolidation can help you save money. Merging all your high interest debts into one lower interest rate debt will help you save money. It will also make your debt payments simpler and easier.
Settling different debts at a time is cumbersome and stressful, so consolidating them into one loan will give you a clearer view of your financial situation.
It also helps you to maintain a payment plan and beat deadlines as you don’t have to make different payments at a time. Debt consolidation helps you to improve your credit score as long as you keep and maintain the payment plan.
Advantages Of Debt Consolidation
1) Debt consolidation is good for people who have multiple debts with high interest rates. People who have a lot of debts with different interests’ rates should merge all into a single loan to reduce the interest rate.
2) It gives the debtor a holistic view of the entire debt. When you consolidate your debt, you will know exactly what you owe and have it at the back of your mind at all times. Having different debt obligations is mentally exhausting as you will need to remember all.
3) It enables the debtor to meet up with repayment targets. When you have merged your debt into one debt, you have a better chance of meeting your repayment targets.
Paying different loans monthly is stressful and if you are not careful, you might forget one or two. So merging consolidating them into a single loan will help not to miss any of them.Â
4) It can reduce the total amount of money to be paid especially if the new loan has a lower interest rate. If the new loan has a lower interest rate, it will reduce the amount of debt that you are expected to pay.
Not every personal loan has a low interest rate, so you must do your research properly before signing the agreement.Â
5) It can boost one’s credit score especially if the repayment plan is strictly followed. The interest here is not on amount owed, but on the payment history. One who makes efforts to pay off debts has a better credit score than someone who does not make efforts.
Disadvantages Of Debt Consolidation
1) Not every loan can be consolidated: Not every loan can be consolidated.
2) The debtor may end up paying more interest if he or she didn’t do properly research. If the debtor did not carry out a research, they may end up paying higher interest rates on the new loan.
3) They may lose their collateral: People may lose their collateral if they fail to pay their loan.
4) You will put your assets at risk. You may not loose your assets, but putting them through such a risk is not advisable. The emotional trauma one undergoes during this period is better imagined.
Does Debt Consolidation Affect Credit Score?
Yes it does. Both positively and negatively. But depending on how you manage the situation, it will improve your credit score over time. Consolidation tools that can lower your credit score:
1) Requesting for new credit: When you wish to consolidate your debts using new credit, the creditor will research on your credit history. Your long retinue of unpaid debts will lower your credit score temporarily.
2) Opening a new credit account: When you want to open a new credit account, it will lower your credit score as lenders will usually see your new credit account as a new risk thus, making your credit score to drop down.
In the positive side, when you merge all of your debts into a new loan and stick to the payment plan, your credit score is bound to rise. This is because your payment history is the biggest factor in determining your credit score.
Ways Of Consolidating Debts
1) Personal loans: These are loans from banks, credit unions or online loan apps. These loans can be used to pay off other existing loans. The repayment plan and the interests are set by the lender. Many lenders do not need collateral to offer these loans, so they are always unsecured.
The payment period can go between months to a couple of years. When taking off a personal loan to consolidate your debts, you must pay close attention to the interest rate and payment conditions on the new loans as failure to follow promptly will affect your credit score and render your consolidation efforts futile.
However, taking out personal loans to settle your debts is a sure banker to a life free of debts.
Interest rates, repayment plans and conditions vary greatly from lender to lender so you should find the one best suited for you.
Benefits Of Debt Consolidation Using Personal Loans
1) Reduction in interest rates: Personal loans can have lower interest rates than all your previous loans. This reduction in interest rate will help you pay off the loan faster.
a) You will have a payment time-line. When you sign personal loan agreement, you must follow the time line to repay the loan. You will know how long it will take to finish the payment and your monthly payment obligation.
2) Balance Transfer Credit Card
You can also obtain a balance transfer credit card which allows you to pay no interest fees for a period of time. Your creditors will determine the amount you can transfer to your card.
3) Home Equity Loans
If you have equity shares in your home as the owner, you can use the house to obtain loans as collateral. This allows you to channel all your time and energy into paying off your home loans.
When using your house as collateral, you must be careful, as you can loose your home if you default on the loan or fail to pay back.Â
4) Retirement Loans
You can take advantage of the retirement savings and pay off existing debts. Borrowing your pension contributions is another effective way to consolidate your debts. But you should also be careful because if you default on the payment plan, you will incur extra tax and other fees.
Debt Consolidation Calculator
Debt consolidation calculator is a tool used to calculate and estimate the length of time it will take to clear one’s debt. Using the calculator, you can adjust your monthly payments or even adjust the number of months you wish to make the payments.
Using most calculators you can see how much you each month, the interest rate, the length of time you have to pay which all depends on the information you provided. These calculators work based on the information you have provided and do not take into consideration all the other factors that might come up eventually.
Most Of The Calculators Require:
1) Total debt owed: There is usually a place to input the total amount of debt owed. Here, the debtor is expected to put in the total amount of debt owed.
2) Interest rate: Here, you input the interest rate of the debt. This is important because you are expected to pay for the interest rate. Stating the interest rate helps the software to add the total interest to the amount to be paid.
3) Expected monthly payments: This is the fraction of the total amount you expect to pay monthly. This can be fixed by the creditor or the debtor. The software will divide the total amount of debt by the amount of your monthly payments you provided to tell you how many months you have to pay.
4) Desired months to pay off: This is the number of months you wish to spread the loans to. Using this, the software will divide your total debt into the number of months you provided to show you how much you must pay monthly to clear the debt in your expected time.
Risks Involved In Debt Consolidation
1) The prominent risk involved in debt consolidation is losing your assets. Assets used as collateral for obtaining the loans can be lost if the debtor defaults on the loan. Assets such as houses, companies or businesses can be lost to the creditors.
2) You could end up paying more than the original loan.
3) You can end up with a deeper debt.
Debt Consolidation is a Tool of Debt Management.
It is a clever way of managing your debts while paying them gradually. From time immemorial, people have been borrowing money to settle their immediate needs as money is always limited.
The plans for repaying such debts must be well planned and thought out. The creditors can come for their money at any time. You must have a plan to pay back together with the interest before the expiration of the grace period.
Keeping your credit score clean and neat is good for individuals and businesses as they will be eligible to receive loans and credit cards when they need it.
Financial integrity is important to business owners and entities. So make meaningful efforts to pay off your debts before they drag you into problems.
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