All You Need to Know: What Is Debt Consolidation and How Does It Work?

Debt settlement is the process of taking out a new loan with a lower rate and using it to pay off other debts. If your credit score has improved since you took out your current loans or if you have trouble remembering payment dates, debt consolidating may be a great way to streamline loans while decreasing your monthly payments.

One loan or credit card may be used to pay off many other loans, consolidating your debt payments. If you have one loan EMI rather than many, it may be easier to pay off your debt. Furthermore, you may even be able to negotiate a reduced interest rate with your lender.

What is debt consolidation?

Simply put, debt consolidation is taking out a new loan to repay existing debt. When many debts are combined into one larger commitment, like a single loan, the payback terms are often more beneficial for the borrower. Some benefits include a lower interest rate, a smaller monthly payment, or possibly both. Debt consolidation can help you handle credit card debt, student loans, and other debt.

How does debt consolidation work?

The first stage in debt consolidation is to apply for a private loan, a credit card with a balance transfer, or another debt-consolidation product through banks or another lender. You can pay your other debts when you are consolidating a loan.

Alternatively, you can request the loan amount in cash and pay off all outstanding debts. Many balance transfer credit cards provide a standard process for merging your present credit cards.

After paying off your existing debts with the money from the new loan, you will have to pay one EMI on the new loan. Debt consolidating lowers your monthly payment amount by extending the loan terms.

Consolidating loans helps those who struggle with managing money. Consolidation works by streamlining payments and improving budgeting. Many lenders collaborate with you if you are consolidating your debt. This is because it makes it easier for you to make on-time payments. This is favourable for all lenders.

You will need a good credit score to be granted a loan with an interest rate lower than your present loans. If your current lender needs help finding a loan option or if you are not eligible for the options they offer, you can talk with another lender.

Types of Debt Consolidation

There are two primary types of debt consolidation loans: secured and unpaid. Your asset, such as a house or car, serves as security for a secured loan. The asset itself acts as collateral for the loan. The asset is seized if you cannot repay the loan.

On the other hand, unsecured loans are not backed by any assets. They have higher interest rates and lower principal amounts. Loan interest rates are often lower than credit card debt interest rates. Moreover, the rates are fixed, which means they stay the same throughout the repayment period.

How do you consolidate debts?

There are many ways to collect your debts, including paying them all at once. A few are mentioned below.

Loan for debt consolidation

Lenders often offer specific loans for debt consolidation. These are types of personal loans created just for debt consolidation. Debt consolidation loans include a fixed interest rate and term to provide more reliable repayment terms.

Debt management plans

You can enrol in a debt management plan (DMP) to combine your outstanding debt. DMPs are often used to help repay credit card debt. As soon as you join the plan, you stop paying payments to your creditors. Instead, you make a lump sum monthly payment to a credit counselling service. Then, the amount is dispersed to your lenders by your credit counsellor.

Loan consolidation for students

The only purpose of these loans is to convert multiple student loans into one private loan with a single payment. This approach may be useful if you have multiple student loans with various services.

House equity loan

To combine debt with a home loan, you need to get a loan secured by the value of your home. The lender disburses the funds all at once. You are free to divide or pay off your debts with the amount. Therefore, since your property serves as security for the loan, you can be certified for a lower interest rate provided for debt-consolidating loans.

Charge cards

Another tactic is to transfer all credit card payments to a new card. The process is only used if the new card provides low or no interest rates. You can also use the debt transfer option on your existing credit card if it offers benefits.

Pros and cons of debt consolidation

Pros of debt consolidation

• Debt management is simplified by combining loans into a single, clear payment.
• The overall interest rate of your loans may be lowered by consolidating debt into a secured loan, a credit card balance with no interest, or a reduced personal loan.
• Fixed loan payments can help you pay off large credit card debt quickly.

Cons of debt consolidation

• Lenders may charge fees for lending money, a balance transfer, or loan closing.
• Some lenders may ask for collateral.
• You may receive higher interest rates if you have poor credit scores.
• The tenure of the loan is longer.

Conclusion

Debt consolidating is a simple and effective way of combining all your debt. This technique is helpful for those who do not have good financial management. However, you need a high credit score to combine your loans.

You should consider consolidating your debt only if you have a steady income and can afford your monthly payments. You can also look at personal loans before consolidating your debt. If you don’t know where to start, Piramal Finance can help.