Debt consolidation involves borrowing a sum of money equal to or greater than the sum part of all other forms of credit. This loan is used to clear all of your debts. Instead of having to deal with multiple credit obligations, you will make a single, affordable repayment to one creditor for a defined term. Contrast this with money owed on your credit card (called revolving debt) where debt can continue indefinitely.
We asked Kevin Pickup from The Debt Line, how does debt consolidation work if you have a poor credit history? If you have bad credit, it is still possible to consolidate debt with a loan, provided that you are a homeowner. This is based on the proviso that sufficient equity is available in your home. The provision of collateral means that the risk posed to the lender is reduced so an adverse credit history won’t be an issue. However, it is likely to make the cost of borrowing more expensive.
The term of a debt consolidation loan can be as long as the primary mortgage but could be for as little as a few years. The borrower can spread the cost of borrowing and reduce monthly repayments to a level that is affordable. Remember that more cumulative interest is paid the longer the loan lasts. This is only favorable for the lender.
How does debt consolidation work for small loans? Secured loans aren’t suitable for borrowing a small sum of money due to the various legal formalities involved. However, there are more flexible loans available where the borrower can use funds when the need arises.
The borrower enjoys complete freedom in terms of how the loan is spent. Some homeowners choose to clear debt as well as borrowing money to buy a car, perform home improvements, start a business or pay for an overseas holiday. These various forms of spending can be combined without further complicating finances.
How does debt consolidation work in the event of default? Securing any source of borrowing on the family home is a serious decision. If you fail to keep-up with the repayments, you could face mortgage foreclosure. Think carefully before turning unsecured into secured debt.
It is important to appreciate that there are other ways to clear debt. It may be better to pursue a debt solution, such as a debt settlement program, filing for bankruptcy or a debt management plan. However, these will affect personal credit scores for up to 10 years.
Pros & Cons of a Debt Consolidation Loan
A debt consolidation loan involves putting all loans, credit card, car and miscellaneous debt under one roof and making a single, affordable monthly payment. The objective of this strategy is to reduce, as well as simplifying, family finances. Find out how this works in practice.
Advantages of Debt Consolidation Loans
Lower monthly payments. Combining the total amount owed and spreading the cost over an extended period of time allows a homeowner to reduce the amount that goes towards repaying debt each month.
Simplify family finances. Paying multiple loans, credit cards and car payments can be very time consuming. it is much easier to make just the one payment each month.
Avoid missed and late payments. Making multiple payments each month regularly results in customers failing or forgetting to pay. Missed and late payments can lead to additional fees. A debt consolidation loan can help a homeowner avoid these further charges.
Lower interest rate. Taking out a loan to consolidate debt is considerably cheaper than making minimum monthly payments on credit card debt. Unpaid balances normally accrue interest at up to 20%, with no defined term. However, it is worth seeing whether an interest-free credit card balance transfer is possible.
Avoid bad credit. Greater affordability may mean that a struggling homeowner is able to avoid missed or late payments and getting a bad credit rating. This would not be possible if a debt solution, such as debt settlement or chapter 7 bankruptcy, had been opted for.
Tax deductible. Unlike credit card debt, it may be possible to deduct any interest paid from your taxes.
Variety. There are a number of different loan products available. This means that homeowners are able to shop about, using price comparison sites, to identify the cheapest and most affordable loan.
Convenience. It is remarkably easy to get a HELOC or home equity loan. Most providers offer a great deal of help and assistance to borrowers.
Disadvantages of Debt Consolidation Loans
Secured debt. Turning unsecured into secured debt gives creditors greater powers in the event of default. This could lead to mortgage foreclosure in certain instances.
Debt solutions. Debt Management Plans and debt settlement cannot be used to deal with financial difficulties with respect to secured debt. Even chapter 7 bankruptcy cannot write-off debt, although it can be used to buy a homeowner time to get family finances back in order.
Variable rate. The majority of debt consolidation loans are only available at a variable rate. This can cause financial difficulties should rates rise sharply.
Loan duration. Whilst extending the term of a loan helps to reduce monthly payments, it often means that more interest is cumulatively paid. This can be the case if the rate of APR is a lot lower.
Borrow too much. A common mistake made by homeowners is that they borrow too much money. The temptation of buying a new car or paying for a foreign holiday only serves to increase personal debt. Don’t forget that this is secured debt.
Early redemption. Some providers charge a substantial fee for paying-off the loan early. This is due to the costs associated with setting-up this source of borrowing.
Failing to shop-about. Homeowners regularly fail to trawl the market for the best deal. Not using an online comparison site is likely to mean that higher monthly payments will be made.
A debt consolidation loan can help to improve affordability, but think carefully before turning unsecured into secured debt. Consider various debt solutions, such as a debt settlement plan, before proceeding. If you decide to proceed with a loan, always shop-about in order to find the best deal.