Debt Consolidation
Debt consolidation is the combining of several debts into one large loan with better repayment conditions (lower interest rate or monthly payment, or both). It is a new loan to cover other liabilities and debts. Student loans, credit card debts, and other liabilities can be combined and repaid through debt consolidation.
How Debt Consolidation works
Debt consolidation combines different types of liabilities into one credit. One large loan with other terms is formed for this amount, which allows to repay all other debts. Different forms of financing can be used for it, and payments on the new debt are made until the debt is totally repaid.
If a person has a good credit history, he or she can apply to his or her financial institution for a debt consolidation loan. In case of rejection, the person can apply to a private mortgage company or lender.
Lenders have several reasons for providing debt consolidation. As a minimum, it almost guarantees repayment by the debtor. Usually, banks or credit unions can offer debt consolidation. Also, there are specialized companies that provide debt consolidation services.
Debt Settlement vs. Debt Consolidation
A debt consolidation loan does not cancel the original debts. Debt consolidation is a change of lender or credit type. Debt settlement instead of debt consolidation can be considered for debt relief. This option is suitable for those who cannot get a loan because they do not meet some requirements.
Debt settlement is not about changing the number of creditors, but about reducing liabilities. There are debt management companies and credit counseling services. They don't provide actual loans. They help renegotiate existing debts.
Types of Debt Consolidation
Debt consolidation is divided into 2 types: secured and unsecured.
Secured loans have collateral. Assets (a house, a car, securities) can serve as collateral.
Unsecured loans have no collateral. They have some disadvantages: they are much harder to get permission for; they have small qualifying amounts and higher interest rates.
Interest rates on loans are often fixed and do not change over the period of repayment. In addition, they are usually lower than on credit cards.
There are several ways to consolidate liabilities into one credit. The most used ones are described below.
Debt consolidation loans. A lot of financial institutions (banks and lenders) can provide debt consolidation loans to borrowers who want to cover several liabilities with high interest rates. These are needed for consumers who have problems with controlling the amount or size of debts they have.
Credit cards. All credit card loans can be combined into one new credit card if its interest is less or nonexistent for a specified period of time. Also, there is a function to transfer the balance to an existing credit card. In some cases, there is a special promotion for such an operation.
HELOCs. Consolidation can also be applied to home equity loans or home equity lines of credit (HELOCs).
Student loan programs. Private loans are not covered by this program. In case of student loans and direct consolidated loans under the Federal Direct Loan Program, people can get new terms with a new weighted average rate of previous debts.
Pros and Cons of Debt Consolidation
Debt consolidation is advantageous not in all situations. On the one hand, all payments are combined into one. On the other hand, the payment for the entire term of the loan may be larger.
Pros. Debt consolidation is the combination of several debts with high interest rates or monthly payments in one loan with a lower interest rate. This is convenient for those whose debts are $10,000 or more.
If you don't take on additional debts and repay the new loan on time, you can pay it off faster and reduce the negative impact of collection agencies.
Cons. The debt consolidation may have lower interest rate and monthly payment, but the payment schedule may be longer. As a result, the total amount of payments will be higher. Consider the term of the debt at the current rate before applying for debt consolidation. Compare that term to the term of a possible new loan.
School debts have special discounts of interest rate or other benefits. When debts are consolidated, any discounts or benefits can be canceled. Those who do not pay school loans under consolidation usually have their tax refunds confiscated and may even get their salaries seized.
Debt Consolidation and credit scores
Debt consolidation can have a positive influence on credit score in the future. The sooner the principal is repaid, the more money stays in the pocket. This helps a borrower's credit score be more attractive to lenders in the future.
Longer debts with a consistent payment history are more valuable in a credit score. Therefore, transferring existing credit to new credit can have a negative influence on the credit score.
In addition, paying off old debts through one new loan may cause the reduction in total available sum and an increase in the debt-to-credit utilization ratio.
Requirements for Debt Consolidation
The list of requirements differs from lender to lender. Most often, credit history, a certain income level, creditworthiness, a letter from your place of employment, two months' statements for all debts to be paid, and documents from creditors or repayment agencies are required.
When approving debt consolidation, it is necessary to prioritize the order in which the debts are to be paid. Often it is up to the creditor to decide which loan should be repaid first. If the decision is left to the debtor, it is best to start with the loans with the highest interest rate. However, if there are troubling debts with lower interest rates (family conflict over a personal loan), then you should start there.
