Debt consolidation refers to the process of combining several loans and turning into a single loan. This doesn’t mean that you have paid off or completed any debt, but it means you have transferred several debts into one loan. The amount that you owe is still the same, the only difference is that you get to enjoy certain benefits such as lower monthly payments and lower interest rates. Not to mention, a single loan is more convenient to manage than several loans.
Here’s an example: You owe $1,000 on your first credit card, and $1,800 on your second credit card. Both credit card charges 18 percent APR. To consolidate the debt, you will get a $2,800 loan to pay off these debts, and ideally, the debt consolidation loan will have a significantly lower interest rate.
Reasons for Consolidating Your Debts
People have various reasons for consolidating their debts, but the two most common purposes of debt consolidation are:
- To save money – This is the best reason to consolidate your loans. If you have several credit card debts, this can work well for you. As you know, credit card debts charge high interest rates. This is why, it can be difficult to resolve these debts. But if you consolidate using a loan that has a lower interest rate, you get to save money in the long run. You can put more of your money to reduce your loan balance so you can get rid of your debts more quickly.
- To make payment more convenient – As mentioned earlier, it’s a lot more convenient to make a single payment than to pay multiple loans. This will help make sure that you do not miss out on payments so you can avoid late penalties.
Risks of Debt Consolidation
While the two benefits sound appealing, you need to know that debt consolidation also comes with certain risks. These include the following:
- Increasing costs – There are times when debt consolidation does not lower your costs, but only increases it even more. This is true for those that make you pay for a longer period. If you want to have lower monthly payments, this means that you will pay for the loan longer. The longer the loan term is, the more costly it also becomes.
- Collateral risk – If the debt consolidation loan that you are going to use is secured, this means that you are at risk of losing your home or any other property that you used as collateral.
- Lost federal student loan benefits – If you have a student loan, it has certain features that helps you cope when things get difficult. For instant, you can defer the payments if you become unemployed. Now if you consolidate your debt, you risk losing these benefits.
Applying for Debt Consolidation Loan
To consolidate your debts and turn it into one, you need to apply for a new loan and the use the funds that you will get from these to pay off your existing debts. You can apply for debt consolidation loans from the following:
- Credit unions
- Online lenders
- Peer to peer lenders
If you have good credit rating, then you will have more options for debt consolidation. You can find competitive rates from all the lenders mentioned above. But of course, you still need to shop around to get the best deal.
Now if you have bad credit, your options will obviously be fewer. It’s also more difficult to get approved for the loan. You might need to consider pledging collateral or getting a cosigner to back up the loan. You just have to weigh the pros and cons of whatever solution you can come up with to see if it would work well for you or not.
See to it that you work only with reputable lenders. Many scammers are known to use debt consolidation loans to set traps to their unknowing victims. Don’t let yourself end up becoming a victim of a scam. Read online reviews first about the lender you are eyeing for before making any final choice.
Debt consolidation may or may not be the answer to your financial trouble. The important thing is that you study extensively about the options available so you can straighten your finances before things get out of control.