Posted on Monday 01 June 2015
In this article, we will look at one of the options you have for getting out of debt . If the collections agencies are knocking on your door and your debt repayments are ruining your budget , a debt consolidation loan can be exactly what you need to get your finances back into order.
Debt consolidation is a very simple idea. The average consumer has debt from a lot of different sources: a credit card or two , a student loan , a car loan, maybe a mortgage . When you take out a debt consolidation loan, this money can be used to pay off all of your debts. You then only have to pay back that one loan instead of a few different ones. This has the obvious advantage of being easier to keep track of. With only one big payment per month instead of a whole set of smaller ones, it gets much easier to plan your debt repayments in advance and work them into your budget.
How do I get a debt consolidation loan?
Your first step should be to talk to your bank or to another reputable financial institution. Some will require you to undergo credit counselling before they will go ahead with a debt consolidation loan, but others will not. After your credit counselling, if applicable, the bank will compare your regular income to your regular expenses and will also run a credit check . This can be a problem. If your debts are already burdensome enough you are considering debt consolidation, it is likely that your credit score has already suffered.
Depending on how large your debt is (and if you are applying for a debt consolidation loan, it is probably quite large) you may need to provide collateral.
What will a debt consolidation loan do for me?
Debt consolidation loans make it far easier to keep track of your debt. if you have six credit cards open, it can be quite easy to miss a payment, especially if you lack financial discipline. A debt consolidation loan gives you one big debt to pay back instead of a lot of small ones.
It can also have a much more favourable interest rate, depending on the makeup of the debt you consolidated. Many people who have their debts consolidated do so because of mounting credit card debt . Credit cards have far higher interest rates than most other kinds of debt, so if your debt is credit card-heavy, taking out a debt consolidation loan can really cut your repayments down.
However, not all debts are eligible for debt consolidation, and your financial institution will advise you on which of your debts can and cannot be included. Mortgage debt in particular cannot be consolidated. However, if you have enough equity in your home, you can apply to your bank to roll your other debts into your mortgage, which typically has a lower interest rate than many other kinds of debt.
What are the downsides of debt consolidation?
It might help to think of debt consolidation as a milder version of bankruptcy , in terms of both its costs and its benefits.
First, it can damage your credit rating. When you consolidate debts, they are paid off immediately. While this will stop them from getting any bigger, it also means that you did not repay them according to the agreed schedule. This looks bad on your credit report. However, it may well look less bad than being unable to pay your debts and watching them pile up.
Second, you may have to wave goodbye to your credit card . This varies from lender to lender, but some will close your lines of credit as part of the consolidation.
However, closing some credit cards might actually be a good thing because third, you need to treat a debt consolidation loan as a wakeup call. If you consolidate your debts and then continue to borrow money faster than you can repay it, the damage to your credit rating has all been for nothing. This isn’t exactly a downside, because improving your financial skills is never a bad thing, but failing to turn your finances around makes the whole debt consolidation process pointless.