Having multiple loans or debts is not a problem until you start missing your payments. This would affect your credibility and make it difficult for you to get other loans. However, challenges in paying off the debt aren’t the only reasons you may consider debt consolidation.
Debt consolidation can potentially help you in many other ways. First of all, it can help you maintain regular payments for your loans and debts. It also lets you reduce the interest that you pay for your existing loans. Thus, reducing the overall payments that you make.
How does debt consolidation work?
In simple words, debt consolidation combines some or all of your existing loans or debts. To some, it might seem like a strange idea. However, if managed carefully, debt consolidation plans can help you manage your personal finances. Shuffling around your debts and credits and taking out another financial product to manage your existing debts can actually, in most cases, benefit you in the long run.
So, how do you consolidate your debt?
Generally speaking, there are three primary ways you can opt for:
- Combining your loans under one umbrella plan.
- Refinancing or mortgage top-up.
- Transferring your credit card debt to a fresh card with a balance.
Let’s give you some more details about these options for a better understanding.
Debt consolidation loan
This is the most common option that many personal loan borrowers prefer. The plan or the system allows you to take out another loan that should combine all your debts into one. This means that you’d be paying a single payment on every instalment, rather than making several payments for individual loans.
Consider the following scenario. Your personal loan would generally be repaid over a fixed term. On the other hand, if you’re paying off your credit card debts, minimum payments may still leave you with a lot of balance and interest.
More so, the term would also keep on extending, depending upon how much you pay back.
Having a single loan to pay off your debts would mean that you know a clear timeframe for when you can be debt-free. It is worth mentioning here that you’re likely to make a higher payment when consolidating multiple loans with a single debt. At the same time, your general term for the loan may be reduced.
This option depends upon your credit score and credit history. The better your credibility, the better the deal you’ll find.
Consolidating your Debt into Mortgage
This option is more suitable for borrowers who have an existing home loan or mortgage. The plan allows you to combine your personal loans or debts with your mortgage, also known as refinancing. To refinance your home loan means you’re increasing the amount you borrow against your home.
It is important to remember that home loans are a form of secured loans, as your home (the asset) is used as collateral. Nonetheless, consolidating your personal debts with your mortgage has several benefits to offer. For starters, you can expect to pay a lower interest rate. This is because home loans generally have lower interest rates as compared to other forms of credit.
You can also expect to be given a longer term to repay your loan. This is simply due to the fact that home loans have a more extended repayment schedule. In addition, you can also expect to be paying off your debt at with lower payment installments.
Thereofre, by consolidating your personal loan with a mortgage, you would marginally increase your mortgage repayment amount but eliminate the payment against your personal loan altogether.
Balance transfer on credit card
Most suitable for borrowers with credit card debts to pay, balance transfers are not so familiar with all sorts of borrowers. Consider the following scenario.
You swipe your credit card for a purchase and pay back in instalments. Ideally, your debt should reduce, but it does not, or at least, not so quickly. What you can do is apply for another credit card. Wondering how a new credit card could help?
Well, typically, new credit cards offer a low or 0% interest rate on the existing balance for at least 6 months. The term could extend up to 2 years, depending upon your credit score and your payment history. And also the plan you choose for your credit card. Within this time period, you can actually pay off a massive portion of your debt. Resulting in lowering down the actual repayment you make towards your loan.
However, you should be aware that you may pay a higher interest rate if you don’t pay your balance off within the promotional period. As a result, used incorrectly, this method could lead to you having to pay a lot more than you originally planned to. Moreover, some credit card companies cap the balance that you can transfer. Meaning, they may limit the balance on your previous card. Such a situation could still leave you with a sizable debt to clear.
Can debt consolidation hurt your credit score?
The answer to this question is both – yes and no.
Debt consolidation would hurt your credit score, but this drop is usually short-termed and not so significant. On the other hand, if you continue to repay your debts on time, without fail, it won’t hurt your credit score.
It is also important to note that many applicants desperately apply with several creditors with a short period of time. This situation essentially can impact your credit score negatively.
Where to find help for debt consolidation?
Generally speaking, some financial counsellors and experts can advise you for taking out debt consolidation. But, it might not be a feasible option for you. The wiser move would be to go for a self-assessment first and then contact your existing creditor.
Your creditor would be better equipped with the solutions to your debt problems. They would likely be familiar with your credit account and its performance. And likewise can suggest to you what would be the best way out for you.
A final word on debt consolidation
Debt consolidation is an effective financial management tool. However, when you consider this option, you need to be extra careful to not fall into a debt trap again. Be regular with your payments, manage your expenses and income, and also keep track of your credit ratings as you move forward.
Keeping these simple yet critical points in mind would help you out of your financial troubles in the fastest way possible.