What is Debt Consolidation?
This is a process that refers to consolidating multiple debts under one umbrella by taking a single loan to pay off the others. When a person decides to consolidate his debt, he or she basically is repaying multiple loans by taking one big loan.
Advantages of Debt Consolidation
- No more multiple EMIs.
- Chances to Improve credit score.
- Make repayment more manageable.
- Single EMI
If you consolidate your debt, you keep track and pay only one EMI as against multiple EMIs in the past. The burden of keeping a trail of different repayment dates and deadlines is off. The debtor can avail of a single loan large enough to pay off various dues of smaller amounts. This helps in repaying all monthly outstanding dues only once a month.
- Lower Rate of Interest
Consolidated loans normally charge a lower rate of interest. But there is a catch in this. Usually, the repayment schedule of the consolidated loan offered is longer than the repayment tenure of the existing multiple loans. The rate of interest looks attractive, but since the repayment time is longer, the final payment may be the same or at times more than what one would have paid for the multiple loans.
- Chance to Improve Credit Score
Poor payment schedules reduce the credit score and make it that more difficult to get new loans, as and when required. Skipping even one EMI hurts the credit history of a person. With a single EMI, the chances of skipping the repayment are minimal, unless of course, the finances are poor. Moreover, the single loan will erase all the current debts and immediately improve the credit score.
Terms to Look for when You Consolidate Debt
You should consolidate debt only if it is convenient in the long term. There are some conditions which should be ticked if you are opting for this.
- Lower rate of interest.
- Reduced monthly outflow.
- Convenient pre-payment plan.
How to Consolidate Debt?
There are numerous ways by which a person can consolidate his debt.
- Personal loan
- Balance transfer
- Loan against property
- Personal Loan
This is the simplest way to consolidate debt. Always look if the interest rate is lower than the average interest rate of the other loans which you are aiming to consolidate. Personal loans are offered by banks and financial institutions. The eligibility to avail a personal loan depends upon the existing credit score and financial position. Most personal loans are unsecured. There is no requirement for them to give any collateral.
- Balance Transfer
Many credit card companies give their customers the option to transfer the current outstanding on one or many credit cards to them at a lower rate of interest. For example, if you are paying for purchases made on three credit cards, the company will offer to transfer the total outstanding on the three cards to one credit card, at times at a lower interest rate.
- Home Equity Loan
This is also called Loan against Property. This option to consolidate debt is for those people who own a house or a fixed asset. The loan is given against the total market value of the property which invariably will be much higher than the accumulated loans taken to buy consumer durables, motor cars or the outstanding on credit cards. But do remember if you can’t repay this loan, you end up losing your house.
Be Careful when You Consolidate Debt
- While the whole idea of consolidating debt, putting all your eggs in one basket looks attractive, do note that this comes with some disadvantages.
- Rate of Interest may be higher. If you opt for a variable rate of interest, the interest will keep fluctuating according to the market conditions. In all likelihood, the interest will be higher after a certain period of time.
- With the repayment timeline extended, you could end up paying more than you would if you continued with separate loans.
- Sometimes the initial one-time fee paid ends up making a significant hole in your pocket.
- You put your assets at risk if you opt for Home Equity Loans. Non-payment of EMIs could see you lose the property to the lender.
In conclusion, the idea to consolidate debt is good. But it comes with some very critical caveats. Be alert to the disadvantages and then take a considerate decision.