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Quick Guide to Debt Consolidation

If you are looking for a way to manage your various high-interest credit card balances, you might have come across the term “debt consolidation.” In the right situations, debt consolidation can make it easier and faster for you to pay off your existing debt. This loan can also reduce your monthly payments. Nonetheless, debt consolidation is not ideal for everyone. If you use it in the wrong circumstance, you can end up worsening your financial situation.

What is Debt Consolidation?

Debt consolidation is the process of combining multiple debts into a single loan obligation. This loan is offered by credit unions, banks, and other financial institutions. When consolidating your debt, you will not be “paying” the old debts at once. Instead, you will be moving them into one larger debt. Debt consolidation aims to lower your interest rate, offer one monthly payment and lower the amount you pay each month on your loans.

To understand if debt consolidation is a good option for you, you should find out if the type of debt you have can be consolidated. It would help if you also weighed in the advantages and disadvantages of debt consolidation before making your final decision.

To give you a better understanding of debt consolidation, below are some of the unsecured debts that can be consolidated:

  • Petrol card bills
  • Department store cards
  • Utility bills such as electricity and phone bills
  • Hospital and medical bills
  • Personal loans that are not secured by your property or home

Some of the debts that cannot be consolidated include:

  • Legal statements
  • Auto loans
  • Home loans and mortgages
  • Lawsuits
  • Boat loans
  • Back taxes

Debt consolidation will be ideal for you if you can make a minimum monthly payment on your debt. This is because the financial institutions will not reduce your principal amount; they will only reduce your minimum amount. If you are not sure if debt consolidation is your best option, you can seek help from a credit counsellor. However, here are some of the benefits and drawbacks of using debt consolidation.

Advantages of Debt Consolidation

  1. It simplifies your payments. All your debt will be rolled into a single monthly payment, which will make it easier for you to manage your debt. After consolidating your debt, you will only have to worry about one debt.
  2. Lower monthly payments. A debt consolidation loan will offer you a lower interest rate, and extend your payment period, thus lowering the amount you spend on your debt.
  3. It can improve your credit score with time if you commit yourself to make timely payments.

Drawbacks of Debt Consolidation

  1. You may lose your property. Most financial institutions require you to secure the consolidated loan. Therefore, you could lose your home or any other property in case you fail to pay the loan.
  2. It extends your repayment period. Consolidating your debts will not only combine your debt into a single payment but also extend your repayment term. You may enjoy a lower interest rate and lower monthly payment, but you will take longer to pay off your debt completely.
  3. Your credit rating may reduce the short term. Once you enroll into a debt consolidation program, your credit rating will reduce significantly. The program you enroll in will determine the points that you are going to lose. However, this will be for a short period because debt consolidation will improve your credit score in the long run.

How to Consolidate Your Loan

Step 1 - Determine the Amount of Debt That You Want to Consolidate

First, determine how much loan you need to clear. For instance, if it is medical bills, store credit cards or personal loans. Have in mind that some lenders may allow you to consolidate your student loan. If you have debts such as mortgages or home equity loans, lenders may not allow you to consolidate them.

Step 2 - Do Your Research to Find Out the Best Loans

The lending standards vary among lenders. For instance, the repayment period or credit score requirements may vary. The maximum amount that can be consolidated may also vary among lenders. Shop around to find the best quotes. You can check with the local credit unions or banks, use online comparison tools to compare loans offered by various lenders, and the offers you may be getting in your mailbox.

What you should be looking out for when doing the research is a low APR, low or zero origination fees, a debt amount that will cover all your debt, and a provider that does not charge penalties for extra or early payments.

Step 3 - Apply for The Loan

When applying for the loan, the financial provider will look at the following factors before approving your request:

  • Your existing debt
  • Your credit history and credit score

The lender will also ask you the purpose of the loan. Since it is for consolidation, they ask for your accounts and current balances. They will then use this information to determine your eligibility.

The lenders will check your credit score to determine your creditworthiness. For your request to be approved, your credit score should be the same or above the number on their credit score requirement. They will also check your debt to income ratio to determine if you can afford the loan. Although some financial providers may be willing to approve the loan when you have a DTI of 45, most will accept a debt to income ratio of 41.

Step 4 - Pay Off Your Balances After Getting Approved

After the lender approves the loan either of the following can happen:

  • They can send the funds to the creditors and pay off your balance by themselves or
  • They can deposit the funds to your bank account.

If your debt to income ratio is up to their standards, the lenders will require direct disbursement. Hence they will send the funds directly to your credit card companies. The reason as to why they do this is to ensure that you strictly use the funds to pay the debts as you had said in the agreement.

If a direct disbursement is not essential, then the funds will be sent to your bank account. The balance may take a few days before reflecting on your account.

Step 5 - Pay Off Your Loan

After paying off your debt, the consolidated loan should be the only unsecured debt you have. You will need to pay it in instalments. Some tips such as setting a budget, making extra payments if possible, and avoiding new credit cards can help you to use the debt consolidation loan more appropriately.