Juggling several monthly debt repayments can get hectic and expensive depending on the interest rates on each. Sometimes, rolling these debts into one monthly payment can help you stay more organized and if you are lucky enough to get a lower interest rate, you may even end up saving some money in the process.
This is where debt consolidation comes in handy: A debt consolidation loan is a loan that you take to pay off other existing loans, leaving you with only one creditor to deal with and one monthly installment to pay over a specified period of time.
That being said, knowing the benefits of a debt consolidation loan and how it works can help you decide if it is the right step for you.
Benefits of Debt Consolidation
Debt consolidation comes with several benefits. Nevertheless, realizing these benefits may be pegged on getting a more favorable interest rate on the new loan, ensuring that there are not too many added costs associated with it, and addressing underlying financial problems that got you into debt in the first place.
Here’s how debt consolidation benefits you:
Easier Repayment Schedule
Making a single monthly payment eases the pressure of keeping up with multiple payments and reduces instances of defaults.
Possibility of Saving on Interest Cost
It is possible to get a lower interest rate and save money based on the type of loan you are taking. For example, credit cards come with higher interest rates than personal loans so you would save money if you are taking a personal loan to pay off credit card debts.
Further, you may qualify for a lower interest rate if you have improved your credit score through the repayment of other debts.
Could Ease your Monthly Budget
If you wish to pay lower monthly installments to ease your monthly budget, you can have your debt consolidation loan spread over a longer term. You should keep in mind, however, that it could turn out to be more expensive in the long run.
Better Planning and Motivation
With one fixed payment, you are able to ascertain when you will finish paying off your debt. This will not only motivate you but also help you make better financial plans.
How a Debt Consolidation Loan Works
For debt consolidation, you request a loan equivalent to the total amount of your existing loans. If it is approved, you use the money to clear the other debts. You can then pay the new loan over time. Typically, consolidation loans will come with a fixed rate, meaning that the payments are monthly and predictable.
Certain factors will determine if lenders approve your consolidation loan, and at what interest. These include:
Your Credit Rating
Also referred to as credit score, this is a 3-digit figure that’s at least 300 and up to 850 which indicates your potential to repay a debt. Scores of mid-600 going up make it easier for you to not only get approved for a consolidation loan but also a lower interest rate.
Debt-to-Income ratio or simply the DTI ratio shows the portion of your monthly earnings that is used to repay debts on a recurring basis. A lower DTI ratio is attractive to lenders as it indicates your likelihood to manage loan repayment.
How much you earn will determine if you will be in a position to make payments and lenders would want to verify this.
You may still get some lenders to approve your loan even with bad credit but you should be prepared to pay higher interest rates. Your other options include waiting to improve your creditworthiness or applying for a secured loan where you use an asset as collateral.
If everything checks out though, nothing stops you from shopping around and comparing lender terms to choose one that best suits your interest.
While at it, consider prequalification as it does not affect your credit score. You will want to compare interest rates, associated fees, term length, and amount per installment before you settle for a lender.
If you are juggling several debts and would prefer to handle one monthly repayment, taking a debt consolidation loan can ease your burden.
If you are already struggling to pay your existing debts however, debt consolidation might not help you because you will probably struggle to pay it as well and land in more financial issues- in fact, it may be hard to get approved for one since you’ve probably wrecked your creditworthiness.
So, ensure that you improve your credit first and use the debt consolidation loan as a way to streamline your repayments and possibly get a lower interest rate.