Debt consolidation is a plan that can help you pay off all the loans and debts you have, and, at times, in a shorter time frame. In case you have a large number of smaller loans like credit card balances, bills, payday loans, bank overdrafts, and any other, you can pay them all off at one go.

By taking a larger loan with a possibly lower rate of interest, you can clear these debts, and then focus on paying off the large loan in monthly installments. Since you’re bringing all the multiple debts and combining or consolidating them into a single loan, this process is called debt consolidation.

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Where to Source Debt Consolidation Loans

If you wish to get debt consolidation, you can look for the relevant programs offered by finance companies, banks, and credit unions. These programs are designed specifically for people who are finding it difficult to clear the debts they owe. You have a better chance of getting approved for a loan with a bank or credit union. Should you look for loan with other lenders and financing companies, you may find that you have to pay a higher rate of interest that can go up as high as 47%. The only positive is that these lenders may accept items like household goods including appliances and older vehicles as collateral.

At the time of evaluating the various programs available to you, you may want to take a close look at the debts you already have, the rates of interest you’re paying on them, and the terms and conditions. Compare these factors with the new loan you’re planning to take out. It makes sense to convert the smaller loans into a single debt only if you see yourself paying less interest with convenient payment terms that match your current financial situation.

Should you work out a debt consolidation agreement, you’ll receive the funds by way of any one of two procedures such as:

  • The lender pays off your debts. You now need to make monthly payments to the lender.
  • The lender deposits the funds in your bank account. You can clear the debts using your discretion.

Positives of Opting for Debt Consolidation

Opting for debt consolidation does have its advantages. Here are some of them:

  • You’ll pay a smaller amount each month which makes clearing payment less of a burden. You could get a loan with a program where you’ll pay an economical rate of interest or have a longer time frame, also called amortization period, to make the payments.
  • You’ll find it easier to manage your finances. That’s because in place of keeping up with multiple payments, you need to only maintain records for one single payment.
  • If you can find a low-interest program, transferring your high-interest debts can help you save on money on the total interest you have to pay on your debts.
  • By consolidating your loan, you might find that becoming debt-free is faster. That’s because a section of the amount you would have paid by way of high interest can be diverted towards paying off the principal.

How Banks and Financing Companies Calculate the Applicable Interest

When setting the interest rate on the debt consolidation loan you’re applying for, your bank or financier is likely to take two major factors into consideration.

Your Credit Score

Your credit score is a statistical indication of your financial dependability and indicates whether or not you’re likely to repay the loan according to your agreement with the lender. If you can display a high credit score, your lender will be a lot more confident of getting paid and you raise your chances of getting approval for the loan. However, do keep in mind that even if you did eventually pay off all your previous debts, missing deadlines can also reflect negatively on your credit score.

A high credit score allows you to qualify for a debt consolidation loan without the need to offer any collateral. You might also get the loan at low rates of interest. However, if you have a low credit score, you may not be considered a good candidate for the loan even if you provide adequate collateral.

Collateral You’re Providing

The collateral is the security you’re providing to get the loan. In case you’re unable to pay back the loan, the lender can claim the collateral and sell it to recover the funds. Most lenders like banks and credit unions prefer assets that can be easily liquidated into cash like, for instance, a new car or vehicle you own or property. Items like tools, household appliances, big screen TVs, equipment, or collectibles are typically not acceptable.

The value of the security can also influence the rate of interest you can get. For instance, if you offer your home as collateral, you can qualify for the lowest interest rates possible. But, if you offer a new car as security, you will get attractive rates of interest, but they may not be as good as the rates against a piece of property.

Debt Consolidation Loan Options You Can Explore

Here are a few loan options you should consider:

Line of Credit

You can apply for and get a line of credit with a bank or credit union. Draw and use the funds to clear your existing debts. Lines of credit can be secured like against the collateral of your home. Alternatively, they can be unsecured and you can get approval if you can show a good income and favorable credit score. To make this debt consolidation option successful, you must commit to paying back a fixed amount that is larger than the required minimum payments for each month.

Home Equity Loan

Both banks and credit unions offer you home equity loans also called second mortgages, often at economical rates of interest. You can get approval for these loans against the equity you’ve built up by paying a section of the first mortgage that is higher than the value of the house.

Consolidating Your Debt Through a Financial Institution

Typically financial institutions don’t have stringent lending criteria and getting approval for loans is much easier. But, you may want to be prepared to pay extremely high interest rates that can go up to 47%. Remember, any loans that you take with interest rates of 30% or more usually take 5 years or more to pay off.

Consolidating Your Debt Through a Bank or Credit Union

Banks and credit unions typically offer you debt consolidation loans at attractive rates of interest. If you can provide a good collateral and have a decent credit score, this option is better than getting a line of credit or second mortgage.

Transferring Your Loan to a Credit Card

Many credit card companies offer you credit cards with a low-interest introductory period that can last for 12 months or so. Further, they may or may not charge a fee for transferring your old debts. You can buy this credit card and clear your existing loans. However, it is essential that you pay off the loan and the credit card balances within the introductory time frame. After this time, you’ll revert to paying the regular interest rate of 20%. If you cannot clear your debt in 7 years, you could end up paying twice the amount of the original debt.

Using a Low-Interest Rate Credit Card

You can use this option in case you don’t get the loan you need from a bank or credit union. If you have a good credit score, a credit company may be open to providing you a low-interest rate card to clear your debt. However, it is important that you pay back a much higher sum that the minimum amount payable each month or clearing the entire debt could take a lot of time.

Downsides of Debt Consolidation

Every person has a unique financial situation and at the time of looking for debt consolidation, you may want to take into account all the relevant aspects. When you consolidate your debts, you’ll have only a single loan to manage and make payments towards this debt. You might feel a lot more confident about becoming debt-free having taken the necessary steps to reverse your situation.

However, it is important to realize that the main reason why you have debts in the first place is because of faulty spending habits. If you spend more than you earn, you will continue to carry large debts. Before opting for debt consolidation, you may want to explore the reasons why you got into debt in the first place and work on avoiding those pitfalls. To do this, create a budget and plan your income and expenses. Further, ensure that you can pay back the loan or you could end up with a bigger debt than all the debts with which you started out.

Debt Repayment Program – Your Last Resort

If you can’t qualify for any of the existing debt consolidation options and you’re finding it hard to clear your debt, consider contacting a non-profit Credit Counsellor. This professional will study your financial situation and make recommendations accordingly. For instance, you could get into a Consumer Proposal or Debt Management Program. This program does have its positives and downsides. But, if you can get one, you can avoid paying interest altogether and combine your debts into a single monthly payment. Typically, people become debt-free in 5 years’ time.

Is Debt Consolidation a Good Plan?

Debt consolidation can help you become debt-free in a short time. However, several factors come into play here and the best way to get started is to contact a Credit Counselor. You’ll receive expert guidance that is free of cost and confidential. You can also contact the professional over the phone. Here are some of the pointers to keep in mind:

  • If you have a good credit score, clearing your debt may be easier
  • Plan for your future financial objectives like if you wish to own your home, make lucrative investments, or retire in a specific number of years
  • Debt consolidation can be successful only if you budget your income and expenses carefully. To make this happen, remain committed to cutting back your expenses drastically, and clearing your dues in a short time.