Increasing capacity to consume is a positive sign for any economy. However, with increasing consumer capabilities, debt has also increased in the recent decade. Debt is not a problem as long as you know how to manage it. However, not all consumers can handle debt properly. This leaves them with multiple high-interest debts and limited income to repay them.
This is where financial measures like debt consolidation can bail you out. We will look into the pros and cons of debt consolidation in this article. If you need expert advice on consolidating your debts, visit this page.
What is debt consolidation?
Debt consolidation is essentially the process of taking out a single large loan to repay various outstanding loans. This is done to simplify monthly money management and secure a lower rate of interest on your overall borrowings. Here is what you need to secure a debt consolidation loan:
Depending on the option you choose, your credit score can impact your consolidation interest rates.
● If you take out a home equity loan, your credit score will have a minimal impact on your borrowing arrangement. This is because your home secures your loan. Therefore the risk assumed by credit institutions is low. This translates into a lower interest rate irrespective of your credit score.
● However, in the case of a personal loan, institutions require the borrower to exhibit a high credit score.
● Similarly, if you opt for a credit card balance transfer, you would need a high credit score. Otherwise, the lender might reduce your no-interest period without wavering any transfer charges or origination fees.
Pros of debt consolidation
Here are the various advantages of debt settlement solutions for consolidating your debts:
Lower rate of interest
The interest rate offered by lenders often depends on your previous credit habits and your current credit score. If you have been regular in making repayments during the past 12 to 18 months, you will exhibit a good credit score. This can help you get a fresh consolidation loan at a much lower interest rate. You can use this low-interest loan to pay off several high-interest loans.
● If you opt for a home equity loan, your interest burden can be reduced by as much as 40%.
● In the case of a personal loan, the interest benefit might differ from borrower to borrower. A borrower with a good credit score might be able to save a sizable sum in the form of interest. However, in any case, you need to make sure that your overall cost of interest does not increase after consolidation. This would defeat the entire purpose of the exercise.
It can often become a hassle managing multiple loans each month. It is very easy to miss out on a payment simply because you forgot. Even if you have all the means to pay off your several loans, managing them simultaneously is an exercise. Thus, it makes sense to simplify all your payments through a debt consolidation loan.
You can pay off all your existing applications with this credit. Thereafter, you would just be required to make a single payment every month. This reduces the trouble of keeping track of multiple monthly installments.
You can achieve this through the services of a debt management company. These professionals reach out to your lenders to renegotiate terms of credit. Thus, along with simplified payments, you can also reap the benefits of a reduced interest rate.
Lower monthly payments
When you consolidate your debts, your future payments are spread over a longer period. This leads to a lower payment each month. Thus, if you find yourself struggling to make ends meet with rising monthly expenses, debt consolidation can ease this trouble.
Cons of debt consolidation
Here are a few things that you need to keep in mind before consolidating your debts.
Decrease in your credit score
Whenever you take out a fresh loan, your credit score takes a temporary hit. This is due to several reasons listed below:
● Credit institutions run out hard inquiry checks on your previous credit behaviour to gauge your creditworthiness. Several hard enquiries over a short period can decrease your credit score.
● Remember that the higher the average age of all your accounts, the higher will be your credit score. Whenever you take a new loan, the average age of all your accounts decreases. This leads to a decrease in a credit score too. Similarly, when you close old accounts, the average age decreases. In the case of debt consolidation, both these events occur simultaneously. You take out a fresh loan to close off all your old accounts. Thus, your credit score can decrease considerably.
However, this also presents an opportunity to improve your credit score. Make sure that you make all the repayments on time and not miss out on any installments. This would now become easier as you have only a single loan to manage. With the year of regular payments, your credit score will also start improving.
Risk of falling into a debt cycle
Remember that consolidation is not an end, but a means to inculcate better financial habits. It allows you the opportunity to start fresh. However, it is very easy to slide into old habits that lead you to a financial rut in the first place.
For example, with your credit card debts paid off, it might be tempting to reuse the available credit. However, by doing so, you will only mount additional debt. Thus, it is essential to observe sound financial practices until your debt consolidation loan is paid off.
Higher overall interest
Since your payments are spread over an extended duration, you will end up paying more in the form of interest. Although your monthly payments will reduce, your overall interest will increase.
It is not an offence to face financial troubles. However, continuing with lousy financial habits is undoubtedly detrimental to your future. As such, you might look into using a debt consolidation loan to rectify your past financial mistakes.
If you are confused about which option you should choose, reach out to a financial professional, as they can help you evaluate your current situation and make an informed decision.