There are a lot of people struggling with paying off their heavy debts with high interest rates over their missed payments. There is a way to streamline multiple debts into a single, manageable payment with a low interest rate, which is debt consolidation. We are going to discuss what is debt consolidation, how it works, and if it is a good idea.

What is Debt Consolidation?

Debt consolidation is a process of paying off all your debts within one loan with comparatively low interest rates. You can consolidate your debt by taking a new loan or by using a special type of credit card. Furthermore, the interest rate of the loan is way less than your previous debts you are paying off.

You can go for a personal loan for your debt consolidation so that you can pay your individual debts by using that money. Most lenders prefer to give you personal loans to pay your debts. However, you can also opt for regular loans; there are no restrictions on it.

You can use a new balance transfer card that offers a low or zero interest rate. Transfer all your money to that new card from your previous card. These cards offer low interest rates for a certain period of time, like 6 to 12 months. This is how you can pay your debts without adding more interest to your existing debt.

How does Debt Consolidation work?

Debt consolidation is supposed to help you when you are under huge debt with increasing interest rates, and it has become difficult for you to pay off. You can roll old debts into new ones by combining all your debts into one big loan. You can do this by taking a home equity loan, a new personal loan, or a new credit card with a good credit limit.

Having a debt consolidation can make your life a lot easier because you will have to pay comparatively fewer bills with fewer deadlines. Creditors are often open to help you consolidate your debts because they know the chances of you paying them back will increase.

Example of Debt Consolidation

You will be able to understand the concept of debt consolidation more clearly with the help of an example. Suppose you are someone indebted with a high-interest rate, and you have 3 credit cards, and you owe $20,000 on all of them.

These three cards are charging you an average annual interest rate of 22.99%. You will have to pay $1,048 every month for 24 months in order to bring down the balance to zero. However you will have to pay $4,601 interest during this time.

You can consolidate three of your high-interest credit cards into lower-interest credit cards at an annual rate of 11%. You will pay $933 every month for 24 months. However, you will pay $2,157 interest during this time. If you manage to get a promotional credit card that offers zero interest rate, then your debt will become even lower.

Types of Debt Consolidation Loans

There are two major types of debt consolidation loans you can opt for one that suits you.

Secured Debt

Secured debts are the type of loans in which the borrower has to offer something valuable like a car, house, or jewelry as collateral. This way the borrower guarantees the lender to pay him back. In case you are not able to pay your debt, then the lender has the authority to seize the belongings you offered as payment.

Some common examples of secured debt include loans for cars and mortgage loans. If you miss paying the debt for your house then the bank will take your house same goes for the cars. If you take a loan for a car and miss paying it back, then the lender will take your car.

Unsecured Debt

Unlike secured debt, there is no need for any valuable stuff as security. In case you cannot pay your debt within the decided time then the lender can file a case on you. He can take you to the court in order to take his money back. Nothing else, like a car or property, is involved in this loan.

This loan is granted to the borrower on the basis of his creditworthiness or his promise of repayment. The lender decides the interest rate and restrictions according to your credit worth. Unsecured debts have low interest rates because the government can raise the interest rate by printing more money.

When should you Consolidate your Debt?

Debt consolidation is a smart act to perform when you do not have enough money to pay off your debts. It will help you to improve your finances and increase your credit score. However, consolidating your debts is not always a good choice if you have small debts that can be paid off frequently.

If you are facing debt because of your overspending then you should change your lifestyle and be responsible about your spending. You should be careful about improving your credit score since you took out other loans. Consolidation is only good for you if you are in dire need of paying debt and if it suits your situation.

What are the Risks of Debt Consolidation?

Although debt consolidation is a smart act to pay off your debts there are some demerits of it. The first risk you can face because of this is that your credit score can suddenly drop, which can affect your authority to take a loan in the future.

In some cases, you could end up paying more than your actual debt because of the method you choose for consolidation. Therefore, you should try to pay off your small and payable debts quickly without any debt consolidation.

Conclusion

Debt consolidation is one of the easiest ways to pay off your debts, along with comparatively lower interest rates. There are different methods you can follow to consolidate your debts through a home equity loan a personal loan, or a new credit card. We hope we have discussed all the information about what debt consolidation is.