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A debt consolidation loan could be one of the best ways to get out of debt. However, you need to understand it completely before you finalize your decision to use it. There are other options to get out of debt. While consolidating your debts may seem like the easiest way to solve your problem, there may be another option that suits your debt and financial situation better.
The key to making a wise decision about consolidating debt is to understand it through and through. It is not just about combining multiple debts. You need to know the different effects of this debt relief option on your present financial position. Not only that, you should be concerned about how it can influence your financial future. If you choose this option even if your finances can afford something else, that might make you spend more than you have to on your debts. By scrutinizing the consolidation process and effects, you can calculate how this debt relief program can make or break your finances.
What is a debt consolidation loan?
Simply put, debt consolidation loan is one huge loan that will replace your multiple debts. You will borrow a new loan from a lender who can improve your overall debt situation. If the loan is approved, the lender will pay off your multiple debts leaving you with a single loan.
It is very important that the loan changes something for the better. This improvement may be in the form of a simple repayment term, lower interest rate or more savings. If you cannot find a single improvement, then consolidating debt may not be the best option for you.
Before you consider debt consolidation loan, you have to determine your debt relief goals first. To do that, you have to get a deeper understanding of your financial situation. As mentioned, there are several ways that you can improve your debt situation through debt consolidation. However, you can only choose one improvement.
For instance, you cannot get a lower monthly payment without increasing the overall amount that you have to pay the debt. The lower the monthly requirement, the longer the payment period. When you stretch the payment period, you get to pay more on the interest of the debt. This is true even if you negotiate for a lower loan. On the other hand, if you want to save on the total amount that you will pay the debt, you have to make higher monthly payments. It is not possible to have both lower monthly payments and big savings on the overall debt payment.
Make sure you know your financial goals because it will point to towards the right improvement that you will focus on.
What are the different types of debt consolidation loan?
There are different debt consolidation loan options to choose from.
Balance Transfer Credit Cards
This option utilizes a different kind of credit account. Instead of borrowing money, you will apply for a new credit card that offers an introductory 0% interest rate - or at least a very low-interest rate. Credit cards use this to entice new clients to open an account with them. Take note that this interest rate will only be true for a limited time only. Once the introductory promo is done, the creditor usually increases the interest rate of the card. If you transfer your balance to this new card, the creditor will pay off the original creditors or lenders. You will be required to pay a balance transfer fee to process this. It is usually 3% of the amount that will be transferred. To make this work, you have to pay your debt aggressively for the first few months. While the 0% or low-interest rate is in effect, most of your payments will be credited towards your principal balance.
Debt Consolidation Loans
This option involves an unsecured loan that will specifically consolidate your debts. When your loan application is approved, it is possible that the money will not go to you. The lender will directly coordinate with your multiple creditors and lenders so they can pay off your original debts. Once the debt is paid, you will be notified so all your payments will now be directed to the new lender. Make sure you will not stop paying your original debts until you have received confirmation that the consolidation is approved and processed already. Otherwise, you might end up with an unpaid balance. Before you apply for this loan, it is important that you have a good credit score so you can get a low-interest rate on it.
Some people think that this is the same as debt consolidation loans. In a way, it is the same because they both involve unsecured loans. However, this option will allow you to use the loan on other things - not just to consolidate debt. This is how it differs with debt consolidation loan. You will be the one to get the loan amount and use it to pay off your multiple debts. The new lender will not do it for you. This is the reason why this option can be good or bad. If you do not know how to control your spending urges, you might end up using this loan on something else and not in consolidating debt. That could lead you into more debt. But if you can strictly follow the plan to pay off your multiple debts, this can be a great way for you to simplify your payments. Just make sure that you have a good credit score so you can borrow a low-interest personal loan.
Home Equity Loans
This is the fourth option to consolidate debt. If you have a house and you own enough equity on it, you can use it to get a secured loan. This usually works in the same way as a personal loan. When you get the approval, you can use it to pay off the debt. But this freedom has to be controlled because you might end up using it for something else. If that happens, your debt will only increase and your home will be at risk. In case you fail to pay back your home equity loan, you might lose your home to foreclosure. This is why you need to go into this option with a firm repayment plan in mind. Since this is a secured loan, you do not have to worry about having a good credit score. The collateral will help you get a low-interest rate. Of course, if you have a good credit score, then that would mean you can get the best terms on the home equity loan.
What can a debt consolidation loan do for you?
There are a couple of things that a debt consolidation loan can do for you.
It can simplify your repayment plan.
The primary benefit of this debt relief option is it can simplify your repayments. You do not have to feel confused about the multiple debts that you owe. When you opt for debt consolidation loan, you can transfer all your balances to one credit account. You will only deal with one monthly payment, one due date, and one lender. It cannot get any more simple than that.
It can improve your monthly payments.
Since your repayment is simplified, consolidating debt through a loan will definitely improve your payments each month. For one, it will no longer be confusing. Not only that, you will find it easier to plot it in your budget because there is only one amount to think about. The chances that you will miss out on a payment will be unlikely.
It can aid you in improving your credit score.
As debt consolidation loan improves your repayment and makes it easier to meet monthly payments that will make things easier for you to improve your credit standing. Your payment behavior is one of the strongest influence to pull your credit score up. In a FICO score formula, it is 35% of your score. If you can pay your loans in full and on time, this can pull your credit rating higher. Since debt consolidation loans simplify your payment terms, your credit score will reap the benefits of this debt solution.
It can help you save money.
There are many ways you can save money when you use debt consolidation loans properly. For one, you can avoid late penalty fees or charges. If you can get a loan with a lower interest rate, that can also help you save - especially if you opt to pay more each month to shorten your payment terms. The details of the new loan and the changes it will bring to your repayment terms will dictate how much money you will save.
These are only some of the things that debt consolidation loans can do for your credit situation. It is very important to clarify any questions that you have about it. This is why you should consult with a debt expert if there are questions that are bothering you. Feel free to check with us if you qualify for debt consolidation. We offer free initial consultations with no obligations.
What can debt consolidation loan not do for you?
While there are a lot of things that debt consolidation loan can do for you, there are also a couple of misconceptions surrounding it. You need to identify what these are to avoid having false expectations as you use this option to get out of debt.
It does not end your debt struggles.
Some people think that after consolidating, their debt problems are over. That is far from the truth. You still have a long way to go. You only made your repayment terms easier but you have yet to pay it off. Some people feel the need to relax after consolidating debts. The truth is, you should work harder now that you have consolidated your debts. You have to consider how you can pay this off quickly to save more money in the long run.
It cannot reduce your balance.
If you are looking for debt reduction, this is not the right option for you. Debt consolidation will not reduce the amount that you owe on your debt. In fact, it may even make you pay more - especially if you chose to lengthen your payment terms to lower your monthly payments. That will make you pay more on the interest of your debt. If your finances cannot afford to pay your debt in full, then you need to look to another debt solution because you cannot get it from this one. You might be better off with debt settlement.
It cannot solve the root of the problem.
Finally, do not expect debt consolidation loans to solve the real reason why you are in debt. If the problem lies in your lack of emergency funds or overspending habits, you know that consolidating debt cannot solve it for you. It is necessary to work on disciplining yourself so you can change the habits that got you into debt in the first place.
What are the dangers of a debt consolidation loan?
There are also a couple of dangers when you use debt consolidation loans without understanding it entirely.
It can give you a false sense of debt freedom.
Before consolidating, you had to deal with multiple debts that are scattered across different credit cards and loan accounts. You have to monitor various due dates and you also have to think about the terms of each. After consolidating, you now have one monthly payment to one lender. If your calendar used to display multiple due dates, that is now down to one. This simplicity will fool you into thinking that your debt is not as bad as you thought it was. When you look at your credit cards and see that they have a zero balance that will fool you into thinking that your debt problems are over. The feeling of being in debt is not as stressful as before. This is what will give you a false sense of debt freedom. But the truth is, you have yet to pay off your debts because you merely transferred them.
It can tempt you to spend more.
If you give in to the false sense of debt freedom, that can tempt you to spend more. When you realize that your credit cards do not have a balance because the debt consolidation loan paid it off, it will take all your self-control to keep yourself from using it on purchases. If you succumb to the temptation, you will add more to your balance. Remember, you have not paid off your balance yet. Any amount that you spend using credit will be an addition to your current debt.
It can make you lose an asset.
One of the options to get a debt consolidation loan is to use the equity in your home. If you used a home equity loan to pay off your debts and you failed to control your credit spending, you are putting your home in danger. Once your debt gets out of control again, you might find it hard paying off your home equity loan. Once you miss payments and your loan gets into default, the bank might foreclose on your house.
It can keep you from learning your lesson.
The truth is, debt consolidation loan will only help you simplify your problem. It will not teach you how you can avoid landing in the same situation again. It will make debt payments easier but it will not teach you the habits that will keep you from accumulating too much balance. You have to identify the root cause of your debt situation and learn the habits that will keep you from falling into the same debt pit.
What is the alternative to a debt consolidation loan?
In case you have decided that a debt consolidation loan is not the answer to your troubles, you still have other options before you. In fact, there are two debt relief programs that might be better suited to your specific financial situation.
This type of debt solution can also help you consolidate debt. But unlike debt consolidation loans, this does not involve applying for new debt. You will be working closely with a credit counselor. This debt expert will study your debt and financial situation. They will assist you in creating a Debt Management Plan (DMP). This will be the new repayment plan that is based on your financial capabilities. The credit counselor will present this to your creditors and lenders for approval. Once they agree to the DMP, you will send one payment to the credit counselor. This is the total monthly payment that is indicated in the DMP. The credit counselor will take charge of distributing the payment to the different creditors and lenders. This is how they help you “consolidate” your debt payments. You are left with one monthly payment and the credit counselor will make sure it reaches the right credit account. This service will require a small fee that is no more than $50 a month. For the convenience of having a debt expert help with your debt, this is a reasonable amount. Just make sure that you can meet the DMP because one late or missed payment might compromise the whole plan. Your creditors and lenders can choose to terminate the agreement and you will be left with your old debt payment terms.
The other option that you can pursue is debt settlement. This type of debt relief program will help you reduce your balance. If your finances cannot afford to pay off your debt entirely, you need a debt reduction. Debt settlement involves negotiating with your creditors and lenders so they will allow you to pay only a portion of your debt. In most cases, you will offer them a settlement amount - a lump sum payment that is smaller than the actual balance that you owe. You will tell the creditor or lender that you cannot afford your original repayment terms. Ask them to accept your settlement offer as a one-time payment and any balance that it cannot cover will be forgiven. This option is something that you can do on your own if you have the skill to negotiate your debt. However, you also have the option to hire a professional to help negotiate with your creditors and lenders. There are companies like National Debt Relief that can assist you in reducing your debt. Check with National Debt Relief, the top debt consolidation company, for more details.
Consider these alternatives in case debt consolidation loans cannot help solve your financial troubles. Remember that it is not enough that you pay off your debts. You have to take care of the reasons why you are in debt in the first place.