Debt consolidation is a type of personal loan that you can use to pay off any high-interest debt that you may have, typically stemming from credit cards.
Consolidating any type of debt allows you to use a single loan to pay off one or more credit card balances. This can make your repayment plan much simpler. Depending on the amount of debt and the terms of the loan, it may also save you lots of money and time.
To decide if applying for in-person or online debt consolidation is right for you, it’s important to learn what debt consolidation is, how it works, and whether it’s suitable for you.
Here’s everything that you should know.
Debt consolidation is defined as the act of taking out a new loan to pay off other liabilities and debts that you may have. In simple terms, multiple types of debt are combined into one single (and much larger) debt that must then be repaid.
This new debt usually comes in the form of a loan and has far more favorable payoff terms including a lower monthly repayment amount, lower interest rates, or both!
This makes it a lot easier for people to keep track of their debts and also manage their cash flow when it comes to making timely repayments.
It works by taking out some form of credit to pay off some or all of an existing debt including credit cards, overdrafts, and loans.
If you have multiple forms of debt, you can apply for a type of loan to consolidate your debts into a single and manageable amount that can then be paid off.
As the first step, people tend to apply for these loans through a credit union, bank, or credit card company. These are all great places to start looking for some extra help, especially if you have a great existing relationship with your chosen banking institution.
If you are turned down for having bad credit or there is something else flagged on your application, there are plenty of other options to consider. This includes a creditor as having debt consolidation maximizes the reality of collecting money from a debtor.
There are two main variations of debt consolidation loans: unsecured and secured. You may also consolidate debt using a credit card. We’ll look into these three methods below.
Secured debt consolidation loans are backed by one of the borrower’s high-value items (or assets) such as a car or a house. This then works as a form of collateral for the loan, which is a form of security or a ‘safety net’ for the lender in case you do not make repayments.
If you cannot obtain an unsecured loan for any reason, a secured loan ensures that the lender gets their money even if you cannot pay back the loan according to your agreement.
Unsecured loans, on the other hand, are not officially backed by assets and can be more difficult to obtain. You do not need to offer one of your high-value items as collateral for this type of debt consolidation.
You can only borrow a specific amount with this type of loan, but this figure differs depending on the lender that is offering the loan. Unsecured loans also typically have a much higher interest rate and lower qualifying amount than secured loans.
With either type, the interest rates will still be much lower than the rates that tend to be charged on a credit card. In the majority of cases, rates are also fixed, meaning they will not change during the repayment period.
Another method that is commonly used is to consolidate all credit card debt or payments into an entirely new credit card. This may be a good idea if the credit card charges little to no interest for a specific period.
You might also use the existing balance transfer feature on a credit card, especially if it provides some form of effective promotion on the transaction.
There are a few general reasons people will consider taking out debt consolidation. We have included some of the most common ones below.
- Take advantage of the lower interest rate on their debt.
- Reduce their overall monthly payment amount.
- Limit the number of companies that they owe money to.
- Pay off big expenses such as student loans or a mortgage.
Adopting a debt consolidation strategy is effective if you meet the following criteria:
- All monthly debt payments (including your mortgage or any rent that you pay) don’t exceed half of your gross monthly income.
- You have a cash flow that can easily cover debt repayments.
- You have good enough credit to qualify for a low-interest debt consolidation loan or a credit card with a 0% interest period.
If you have a relatively manageable amount of debt and are simply looking to reorganize a lot of your bills with different payments, due dates, and interest rates, debt consolidation is an effective approach that you can tackle by yourself.
It’s important to remember that debt consolidation won’t provide a magical way to overcome excessive spending habits that resulted in the initial debt. Nor will it be the best solution if your debt is completely overwhelming.
- Never use debt consolidation if you have a small amount of debt to pay off. If you can feasibly pay it off within a year or two, it’s not worth the extra effort or additional interest.
- If your debt totals more than half of your income, you may want to seek some debt relief instead of struggling through debt consolidation.
Debt consolidation is the process of turning multiple debts with different lenders into one manageable and repayable sum with just one lender. It’s useful for individuals with good and bad credit and can often be a more effective way of viewing debts that you may have.