What Is a Debt Consolidation Loan?

Many people who have multiple debts are often advised to consider taking out a debt consolidation loan. This is one option that helps consumers deal with debt. But not everyone has an in-depth understanding of what this type of loan really is. Besides knowing that it means taking out a single loan to cover several smaller ones, there is more to consolidating debts than you may realize. This article aims to give its readers a closer look at this option for debt remediation.

What is a debt consolidation loan?

A debt consolidation loan is just like any other loan in that it consists of two main components, the principal amount and interest. However, it should be large enough to cover all your other outstanding debts simply because you will need the loan proceeds to pay all your existing debts. Consolidating debts allows you a more convenient method of payment and for many people, a smart way to recover from financial debacles. Grouping all your debts into one bill can make it easier for you to become debt-free.

Who should consider consolidating debts?

Most people who opt to consolidate their debt do so simply for the convenience and simplicity of paying a single loan. Others do it in order to secure a lower interest rate. This being said, borrowers who presently have multiple debts and are finding a hard time coping with payment deadlines are the best candidates for debt consolidation. Because consolidating debts brings payments for loans, credit cards, overdrafts and such altogether, one repayment per month on a fixed rate is possible.

What are the advantages of debt consolidation?

Eliminate the hassle of multiple payments
No more stressful moments of keeping up with different repayments with different due dates
Allows easier budgeting of household expenses
Possible lower interest rate
Allows the borrowers to exercise responsibility and discipline over debts
Can improve damaged credit rating when handled properly

What are the check points?

Gleaning from the advantages listed above, it would be easy to conclude that consolidating debts is simple. Do not be misled into thinking that way. While it is true that this option can make your debt management easier, it also carries with it higher risk of getting you into deeper financial trouble if mishandled. It is of utmost importance that the borrower fully comprehends the extent of the loan. This means knowing how much the total amount of the loan is that needs to be paid in full. Also, an extended term of repayment means the borrower must pay interest over a longer period resulting in more being paid back in the long run.

If you have missed payments or in arrears with your present creditors, it is unlikely that you will get the best interest rate. Also, if you miss payments with consolidation loans, expect the penalties to be very steep. It is, therefore, imperative that you be very conscious of your monthly budget for your household expenses. Make every conscious effort to not deviate from it at the expense of your loan repayments.

Unsecured and secured consolidation loans

Consolidation loans come in two forms – the unsecured and the secured loans. Below are their general characteristics:

Unsecured loans – easier, but more expensive

This simply refers to loans taken out without collateral. An example of an unsecured loan is a credit card loan or a personal loan.

Although an unsecured debt consolidation loan helps you simplify debt management, the cost effectiveness of such is dependent on the rate of interest. Ending up with higher interest rate and longer payment terms may turn out to be counterproductive instead.

Secured loans – less expensive, but can be riskier

Secured loans have lower interest because you have to put up a collateral. Normally, these kinds of loans are offered only to homeowners because your loan will be secured against your house. Consolidating your unsecured debts with a secured loan can be very risky. If you are not able to keep up with the payments, you could end up losing your home.

Finding a solution to multiple debts needs careful and thorough investigation. Always bear in mind that when you consolidate your debt you are not erasing your debt even if you get a lower interest rate. Neither is it necessarily a cheaper solution. But if you are serious about rebuilding your credit score and you want to develop discipline in paying your obligations, debt consolidation loans can be an effective method for you.