Debt consolidation rolls all your loans into a single, more manageable plan. Here’s what you need to know to see if consolidating your debts is a viable option.
Are you being overwhelmed with financial burden on multiple loans?
Do you wish you could just pay off all your loans in one go?
What is Debt Consolidation?
Managing your finances can be very tough and confusing at the same time especially if you happen to have a debt load that has been spread across multiple credit card and loan accounts.
To people who have been using payday loans for quite some time now, getting lost in the middle of repayment mayhem is a common repercussion of loan rollovers and reborrowing. And this can cause you to sink deeper into debt.
If you are looking for a way to help you repay your loans a whole lot simpler and easier, a debt consolidation program could be the perfect solution for you.
Also known as debt relief, a debt consolidation program is a financial initiative designed to manage and pay off multiple existing loans in a single payment plan. This is done either by applying for a new loan that is enough to cover the entire amount of all your loans or through a debt management strategy that combines all your loans into one account.
Debt consolidation is a strategy often applied to stay organized in managing one’s finances especially the debt load. Besides, you wouldn’t want to hurt your credit simply because you forgot to check an account or two.
The main concept of debt consolidation is to eliminate multiple repayments with multiple deadlines and varying interest rates. Imagine having to only pay one credit card or loan account to a single lender every month – wouldn’t that be a relief?
What are the Two Types of Debt Consolidation?
You can have debt consolidation in two ways. One requires you to secure a larger loan to cover all active loans while the other is a special type of debt management program which merges all your debt into a single account with a significantly lower interest rate.
Debt consolidation loan
One easy way to manage multiple credit card accounts and / or loans is to acquire a much larger credit. This can be secured from a bank, credit union, or from any reputable lender. The amount of the loan should be large enough to pay off all your existing debts in one go.
Compared to payday loans, a debt consolidation lender looks at the borrower’s credit score. However, this doesn’t mean that a borrower with bad credit has no chance of securing such a loan. In fact, lenders base the loan’s interest and other financial charges on the borrower’s credit history. In other words, you may still get the loan even with bad credit but with more fees and higher interest.
Debt consolidation program
The second type of debt consolidation is one that doesn’t require a loan. For payday loan borrowers with multiple credits from a single lender, debt consolidation programs are a viable solution.
Payday lenders can offer this type of debt relief program wherein multiple debts of a single borrower are merged into a single line of payment. This way, lenders are able to increase the likelihood of successful collection from their borrowers.
On the other hand, third party credit counseling agencies also take part in this initiative. On behalf of the consumer, these specialized debt consolidation service companies negotiate with the lenders for more favorable interest rates. This type of step is agreeable for borrowers with multiple debts from different lenders.
In a debt consolidation program, the borrower sends a single payment to the credit counseling agency. This agency then distributes this payment to the concerned lenders on new negotiated terms. Credit counseling agencies can also help out in eliminating unnecessary financial charges which are the main reasons you’ve been consistently sinking into deeper debt.
The Good and the Bad Time for Debt Consolidation
Debt consolidation can run for up to several years depending on the total amount of debt of the borrower. The interest rates and monthly payments can vary depending on the borrower’s credit rating.
Debt consolidation is not always the right choice for everyone who has trouble keeping up with their monthly payments. In some cases, debt consolidation can do more harm than good so it is extremely important to consider your circumstances first before you hop into the bandwagon of debt consolidation.
Debt consolidation is a good idea if:
- You are overwhelmed by multiple monthly bills.
- You have secured an inventory of all your existing debt.
- If there is a high potential to save on interests and financial charges.
- Your total debt doesn’t go beyond 40% of your gross income.
- Your credit score is high enough to secure a low to 0% interest debt consolidation loan
- You did your research on other ways for debt consolidation.
- You are determined and have the means to pay off the loan within five years.
- You are ready to live a debt free life.
Debt consolidation is not a good idea if:
- Your credit rating is too low for you to secure a low interest loan.
- You are consolidating unsecured loans with a secured loan.
- You are spending more than you earn or if you still haven’t solved your spending problems.
- Your credit card and loan balances are too high or if your total debt stands beyond half of your monthly income.
- Your debt load is too small that applying for debt consolidation doesn’t make sense.
Debt Consolidation Pros and Cons
Same with filing for bankruptcy and debt settlement, going for debt consolidation has its fair share of good and bad.
- You can manage your total debt load in one regular monthly payment.
- You are less likely to miss your monthly payment.
- Consolidating with a secured loan yields significantly lower interest rates.
- You will have lesser paperwork to deal with.
- You can reduce credit damage.
- Budgeting for a repayment every month can be simpler and more manageable.
- You can say goodbye to those late night calls from collection agencies.
- You can save on loan fees and charges.
- It will take you longer to pay off your debt. Average term for debt consolidation runs around three to five years.
- Interests and financial charges return as soon as you miss your consolidation loan repayment.
- Special provisions such as interest rate discounts and rebates will be gone.
- Debt amount is not reduced or forgiven.
What are the Requirements for Debt Consolidation?
If you really have made up your mind in securing debt consolidation to simplify your debt problem, you should start considering its requirements. Applying for debt consolidation is not as easy and as simple as it looks.
First and foremost, an applicant’s total debt amount must never exceed 40% or 50% of his gross income. The lender will also see if you have high creditworthiness. This factor is determined by weighing the borrower’s repayment history and credit rating. Some lenders accept a minimum FICO score of 580 while others go for higher digits.
The lender will also require the borrower to secure a letter of employment which will verify that the latter is currently employed while disclosing employment arrangement at the same time. This is otherwise known as an employment verification letter.
Other documents needed for a debt consolidation loan are at least two months worth of account statements for the concerned loans and verification letters from corresponding lending agencies.
As soon as all requirements are in place, the lender will decide as to which existing loans will be paid off first. This decision is part of the service offered by credit counseling agencies as mentioned earlier. In some cases, borrowers get to decide which lender to pay off first. If you have such an opportunity, make sure to prioritize those with highest interest rates.
What is Credit Card Balance Transfer?
Credit card balance transfer is a special form of debt consolidation. Although this can be a popular choice especially among credit card users, the strategy itself yields its own pitfall and can potentially drag you down in deeper debt.
Credit card balance transfer is a financial strategy wherein existing debt from high interest cards is transferred to a new one with a significantly lower interest rate. Some credit cards even offer 0% interest.
But here’s the catch – more often than not, low interest rates from these cards are just for promotional purposes. This means that regular interest rates will kick in after the introductory period has ended. Low to 0% promotional interest rates last an average of 12 to 18 months.
Paying the monthly minimum of the card simply won’t do. Sooner or later, your transferred debt will catch up with the regular interest rates of the card. Furthermore, on-time payments must be consistently observed every time you use the card on a new purchase. Otherwise, the credit card’s introductory APR will be void. Even worse, penalties are automatically applied.
Considering credit card balance transfer requires one to carefully study promotional offers of the credit card provider. A lot of credit card companies collect fees on balance transfers along with other important conditions. After the transfer, the card holder must make sure to cover the minimum monthly payment before its due in order to continue enjoying the 0% interest rate advantage.
What is Home Equity Loan?
Home equity loan is another viable option to help you consolidate your debt. This is a special type of loan that can be secured against the equity of your home. Determined by the current fair market value of the property, the loan amount should be enough to cover your existing debt.
But just like any other secured loan, home equity loan puts the borrower’s residential property at high risk. Bear in mind that one should be more than determined to make repayments on time until the entire debt is paid off.
Extra Tips to Help You Consolidate Your Debt
Managing multiple credit card debt and loan accounts can be a very tough task especially when it comes to keeping up with the credit’s monthly dues and interests. Although debt consolidation is all about simplifying your debt problem, the task itself is also a complex and risky one.
Here are some tips to help you get the best possible result from debt consolidation:
- Make an inventory of all your existing debts. Come up with a complete and comprehensive list of all your loans and credit card debts. Lenders, interest rates, monthly repayment amounts, debt balances, and repayment schedules should also be included in the list. This way, you’ll be able to have a bigger picture of your credit and strategize a more effective solution. Besides, knowing is half the battle.
- Do your homework on all your available debt consolidation options. There are various ways in consolidating your debts – these are credit card balance transfers, home equity loans, personal loans, home refinancing, and debt settlement. While you’re at it, take time to have a closer look at interest rates, term length, fees, and penalties. Weigh in the benefits and setbacks for each option against your current financial circumstances.
- Make sure that you can stick with the new repayment plan until the debt is paid off. Discuss with your credit counseling agency or debt consolidation lender the terms of your loan and how much you can really afford for monthly repayment.
Managing your debt, especially when it involves multiple accounts with different lenders can be very overwhelming and stressful. Although consolidating your debt may sound like the best possible solution for your current financial crisis, it may not be the case all the time.
First and foremost, the most important first step towards beating your debt problem is arming yourself with all critical information regarding all your existing debts. Talk to a reputable financial counselor to help you come up with an informed choice and secure a greater chance at living a debt-free life in the future.