A debt consolidation loan is a form of refinancing that allows the borrower to get rid of other debt sources. This can be done by securing a loan from only one lender which will essentially be used to pay off other outstanding debt.
Instead of paying monthly amortizations to many different lenders, the borrower will just be paying off one loan. Ideally, the new loan has lower interest rates and more flexible payment options.
Advantages Of Debt Consolidation Loans
Here are some of the reasons why you may want to get a debt consolidation loan:
- Easier Monthly Payments. It is easy to get confused with the monthly payments when dealing with multiple creditors. By consolidating debt, the borrower can focus on paying just one lender every month.
- Lower Interest Rates and Expenses. Putting all debt into one basket can save the borrower a lot of money. For example, combining balances from three separate credit cards can save money on interest charges, penalties, and membership fees.
- Can Improve Credit Score. It is possible for banks to view debt consolidating actions favorably. In some cases, borrowers who consolidated their debt saw a noticeable increase in their credit scores.
Disadvantages Of Debt Consolidation Loans
Of course, there are some disadvantages as well. Here are they:
- Can Lead To Even More Debt. If the borrower isn’t careful, consolidating debt can lead to even more debt. For example, it is tempting to use credit cards that have just been paid off in full. A borrower who lacks in discipline will easily fall into this trap.
- Potential Loss Of Assets. Collateral assets may be required in cases of huge debt consolidation loans. In these situations, borrowers risk losing their house, insurance, car or other assets in the event of loan default.
Who Should Avail of Debt Consolidation Loans?
It is advisable for individuals with high amounts of consumer debt (such as outstanding balances on credit cards) to avail of debt consolidation loans. This will concentrate all loans in one big balance that can be paid off in monthly installments with better interest rates.
What To Consider When Taking A Debt Consolidation Loan
The most important consideration when taking this kind of loan is the interest rate. Ideally, the interest rate should be much lower to what you’d pay if you paid each debt separately. If you have a very small disposable monthly income for loan repayments, look for longer payment terms ranging from 36 to 60 months.