A guide to how debt consolidation works

Are you struggling with paying down your debts? 

We understand that’s a clichéd question and probably how every blog post about becoming debt-free starts but bear with us.

man with debt on his backWe won’t tell you how you need to manage your finances or give you tips such as cutting back on your luxuries, eating at home, or creating the Envelope System. Although these are great pieces of advice, we have something else in mind.

Let’s talk about debt consolidation, which is provided to you by online lenders, such as Jacaranda Finance

What is debt consolidation?

Debt consolidation is a loan you used to pay off your other debts. Confused?

Well, you shouldn’t be! It’s pretty simple: Let’s say that you have multiple debts. Every time your salary comes in, you can’t decide which debt to pay down first. You decide to focus on the small debts under thousand dollars first and leave the bigger ones for later. However, the interest rate keeps piling up, and the collectors call to tell you that you are up to your ears in debt. 

A debt consolidation loan comes in at this point. As the name says, it’s a loan that pays down your debts. You work with an agent to combine all the debts and then come up with a single payment, which is divided into monthly payments having a new interest rate. As a result, you don’t make multiple payments every month, which allows you to pay all your debts together.

This loan comes quite in handy when you are paying a high interest rate on your bigger loans. Debt consolidation can be used to pay the following debts:

  • Car payments
  • Credit cards
  • Medical bills
  • Payday loans

Things to consider before opting for a debt consolidation loan

Before you say “Yay” and make haste to apply for a debt consolidation loan, there are a few things that you need to know. This loan helps you to lower your debts. However, in some cases, the new interest rate is higher than that for individual debts, putting you further into debt. 

However, this is not set in stone. Depending on your credit score and employment history, you might get a loan with a low interest rate. Moreover, if the loan is secured, you won’t have any trouble at all. 

Keep in mind, to make the terms of the loan favourable to the borrower, the monthly payment is reduced; hence, it takes you longer to pay the loan.  Again, the terms differ from lender to lender, and you should always do your research before choosing one. 

Benefits of debt consolidation

Consolidating your debt gives your plenty of benefits. Since each borrower’s situation is different, there might be more to the loan than you read about here. Following are the most common benefits of consolidating your loan:

Single monthly payment

It’s worth repeating that with this loan, all your debts are combined into one. The monthly payment amount is fixed, and you can even set your account to auto. With this feature, the amount is paid one day after your salary arrives.

A defined timeline

Most of the consolidating loans above $2,000 are secured, which means you will be given a set timeline to pay the loan. This works in favour of the borrower as it allows them to think about the future. They can set aside the monthly payment from their salary for a defined period, after which they can start saving. 

Less risk of penalties

The more your debts, the higher your penalties will be for missing a payment. If you miss a monthly payment on your consolidating loan, a penalty fee will apply. Still, the amount will be low, which is better than being charged with multiple penalties.

It improves your credit score

Since you will be paying down your debts in an accelerated manner, you will see a clear improvement in your credit score. Paying off high balance debts has the most benefits, as the increase in your credit score will make you eligible for bigger future loans with a low interest rate.

Secured vs. unsecured consolidating loan

There are two types of consolidation loans: Secure and unsecured.

As the names say, a secured loan is one where the loan is granted based on collateral, which can be your house, car, or savings account. Any loan above $2,000 is considered secured. 

An unsecured loan is a small loan, which is usually paid within a few weeks or a month or two. People usually use this loan type to pay off utility bills. 

Both these loan types also factor into consolidating loans and work the same way. If you need a bigger loan and are asked for collateral, don’t see this as a setback. As we said earlier, if the loan is secured, the timeline of repaying the loan will be short, which will allow you to be debt-free quickly.

Ways to consolidate your debt

Apart from a consolidation loan, which you can get from online lenders, you have two other options:

Home Equity Line of Credit (HELOC)

As a homeowner with equity, you don’t need to look far to get a consolidating loan. You can take out a loan against your house and use that to pay down your debts. However, the HELOC asks for hefty collateral, and that’s your home.

The amount of money you can get from your home’s equity is calculated based on the following factors:

  • Your credit score
  • Your current income
  • The amount of equity you have in the home

Personal loan

A personal loan can be used for various reasons, one of which happens to be for debt consolidation. The best thing about a personal loan is that you can choose your repayment terms. Make sure to talk to multiple lenders to find out how much interest rate they will charge for a 5 year or 10-year period.

So, what are your thoughts on a debt consolidation loan? Now that you know what this loan can do for you, your next step should be finding out whether it is right for you or not.