What is debt consolidation?
Say you have debts 1, 2 and 3 all with different repayment plans and with different interest rates, so to make sure you manage to pay your debts with ease while spending less on interests per month, you take a fourth loan and use it to clear all the other three existing debts so you remain with a single loan to deal with. That is what debt consolidation is. Debt consolidation is taking one loan and using it to pay off all the other loans you have so you only remain with one debt.
You take one large debt with more favorable terms of repayment like lower interested rates and lower monthly payment, use it to pay off other liabilities and consumer debts so that you only remain with one large debt to deal with and hence spend less on interests per month.
What are the types of debt consolidation?
There are two types of debt consolidation secured and unsecured loans ;
Secured loans: You have decided that debt consolidation is the way to go for you. So you apply for a loan but before you are given the loan, you are required to offer one of your assets as collateral say your house or car, so that if you fail to pay back your loan you lose your asset to your lender. That is what a Secured loan is. You pledge a certain property before you are given the loan so that if you do not pay it, you lose the property pledged. An example of a secured loan is the home equity loan.
Unsecured loan: It is the complete opposite of a secured loan. Here you do offer up any property as collateral. You do not pledge any assets so in the case that you do not repay your loan, you do not lose anything. It is only based on your promise that you will pay. That is why it is difficult to obtain these kinds of loans and always tend to have higher interest rates compared to secured loans because more risk is on the lender’s side. An example of unsecured loans are credit card loans.
What is the best way to consolidate our debts?
There are several ways to consolidate our debts including; Debt management plan, credit cards, debt consolidation by personal loans, borrowing from friends and family and home equity loans.
1. Home equity loan
Say you have a house that is worth $30,000 if sold now and the total amount of money you owe different lenders comes to around the $20,000 figure. A person like you qualifies for a loan, a home equity loan. This is because your house’s market value is more than the total amount of money you owe different lenders.
A home equity loan is a type of secured loan where you are given a loan because your house’s market value is more than the total amount of money you owe different lenders. You can use the loan you are given to pay off all the other existing loans you have so that you only have the home equity loan to repay. In exchange of the loan, you are required to repay it with interest which is stable and a bit lower than credit card loans because you are required to offer up your house as collateral. Offering your house up as collateral means that in the event that you fail to pay back the loan for one reason or the other, you risk losing your house.
- Lower interest rates because you are offering your house as collateral.
- Stable rates
- You risk losing your house if you fail to pay the loan.
- You take more time paying back the loan.
2. Borrowing money from friends and family
If you have good friends and loving family members you can talk to them and tell them the kind of financial trouble you are going through at the moment and ask them if they can help you out or not. If they do agree to help you out and give you some money, use the money to pay off the many existing individual debts you have and then embark on paying back the money you were given by your friends or family members.
Some of the advantages of using borrowing from your friends and family members as a way of consolidating your debts are;
- You don’t offer anything up as collateral and that means there is no risk of losing any assets in the event that you fail to pay back the money for one reason or the other.
- Easy. All you need to do is pick up your phone and call your friends or family members or better still go over to their place and tell them of the trouble you are having, which is debts, and ask them if they are in a position to help you or not.
- Flexible. It is easy to reschedule your debt payment. When you are experiencing difficulty at the moment, all you need to do is to tell them of what you are going through and see if they can agree to be paid at a later than agreed date.
- Low or no interest. When a friend or a family member lends you money, he or she will expect you to pay back the money the way it was given to you which means that there is no interest while some will require you to pay back the money with something small on top. However whatever fee it is, it is far less than the interest rates at the bank or that which home equity loan charges.
These are some of the advantages of using borrowing from friends and family members, however it also has some of its shortcomings. Borrowing can destroy the great relationship between the two of you when you fail to pay back the money you were given. So to avoid this, it is advisable that you try to pay back the money given as you agreed.
3. Credit counseling service
You can also use the credit counseling service to consolidate your debts. They have counselors who come up with a debt management plan which suits your situation and also works with your creditors with the aim of getting you better terms on your loan. The counselors can negotiate with your creditors to reduce your loan’s interest rates and hence lower the monthly payments you make towards debts.
However, before you are allowed into the debt management program, the total amount of money you are earning each month must be able to sustain your monthly expenses. Your income must be able to cover your bills. When your income is less than your expenses, you will not be enrolled into the program and alternative methods of dealing with debt like filing for bankruptcy can be adviced. Some of the things you may also be required to do in order to be enrolled into the program is living on a budget and you may also be required to give up all your credit cards.
The debt management plan works in a way that you take a certain amount of money to the counselling service each month and then the counselling service works to distribute the fund you have taken to them to your many creditors. Here, you don’t have to worry about your creditors, all you need to do is to make a monthly payment to the service.
The advantages of using debt management plan to consolidate your debts are;
- You don’t have to worry about paying your several creditors on your own as they do this for you. You don’t have to deal with your creditors directly.
- You don’t offer up any properties as collateral.
- The counselors can work to reduce the interest rates of your loan.
- You make reduced monthly payment towards debt.
The plan also has its cons like everything else do;
- The program is not free as you have to make some payment for the counselling service.
- There are consequences if you do not make your monthly payment to the counselling service.
- You can’t sign up for any new credit cards.
4. Debt consolidation by personal loans
You can also consolidate your debts by applying for a loan either from a bank or credit union which offer debt consolidation loans to people or businesses who have some difficulty managing the number of debts they have. These types of loans are meant for people who have several kinds of high interest debts and want help paying them down.
It’s just like you always take a loan to help you boost your business but in this case here, you take the loan to pay off your multiple debts. You don’t offer anything as collateral and you also get stable rates.
4. Consolidating all your credit cards
This requires you to have a good credit to qualify. Here, you transfer multiple credit card debt into a single credit card. For example, if you have card 1, 2, 3, 4 and all have debts, what you do here is you transfer the debt in card 1 2,3 and 4 into a new card, say card 5 so that now you only remain with card 5 debt to deal with. You consolidate all your credit card payments into a new card. The advantage of this is that you now have stable amount of money you pay towards interest hence it’s easy to budget and also the advantage of low interest.
5. Borrowing from your retirement money
If your job offers a retirement plan, you can borrow money from your account use the money to pay off your debts and then work to restore the account back to its original amount. You are actually borrowing money from yourself so an advantage of using this method is you don’t offer anything as collateral.
What are the advantages of debt consolidation?
1. Easy management of debts
You only have to worry about making one regular payment after you decide to consolidate your debts so you don’t have to go paying each and every debt you have or even keeping track on them.
2. Lower interest rates
You will be dealing with one huge debt meaning more time will be given to you to pay back your loan. When you have more time, then you will have low interest rates on your loan. That is only achieved once you consolidate your debts.
3. Improved credit score
Consolidation reduces the chance of you failing to pay back a loan on a certain credit card. As we all know, failing to pay or paying late for whatever reason can have severe consequences like affecting our score or even making it difficult for us to borrow in the future but through consolidation you don’t have to worry about this because you will be making regular payments each month because of the stable rates you will achieve by consolidating which in turn increases our score.
4. Less risk
When you take several types of secured loans, it will mean that you also give up many assets as collateral which will also mean that once you fail to pay the loan back, you stand losing several assets you worked hard to acquire through collateral repossession. Nobody enjoys this process of repossession and trust me you don’t want to go through it either. By consolidating your loans, you will only be giving up one asset as collateral and by this you will have reduced the risk of losing most of your property and in case you fail to pay back for whatever reason only one asset will be repossessed.
5. Budgetting made easy
By consolidating your debts, you will only be dealing with one debt as I had mentioned before meaning you will have stable rates on your loan. You will know how much will be going towards debt payment payment each month plus intetest and this has an advantage, you will be able to know how much you can live on. You can easily budget with the money you have remaining because debt consolidation brings about a regular fixed payment towards debt.
6. Spend less on debt payment per month
Consolidation brings several debts together and what this does is that it combines existing payments together amd in turn increases the tenure of the repayment. Increased time to pay back a loan reduces the interest rates. Reduced interest rates means you pay less at the end of the month. You are basically paying back the same amount of money but for a longer time because you are paying it back in smaller amounts at the end of the month.
7. Less stress
Dealing with debts can be frustrating but dealing with several debts at a go, is something I don’t wish to go through. Because you have to pay this and that or else you will face the consequences. It is stressful. Through debt consolidation however, the debt repayment process is made easy and manageable. All you have to do is worry about paying a single debt which is less stressful.
What are the disadvantages of debt consolidation?
1. You can lose your assets
Some of the ways in which you can consolidate your debts may require you to offer some of your valuable assets as collateral like it is in the case of home equity loan where you offer your house as collateral. In these cases, it is easy for you to lose your assets when you fail to pay your debts .
2. Increased time
By consolidating your debts like I said before reduces the interest rates of your debts but it does not reduce the amount of money you are required to pay back. Reduced rates yet you are paying the same amount of money means you will take a longer time to pay off the debt completely. This also means that you can end up spending more on the long run towards interests.
3. Difficulty in acquiring them
For the unsecured types of loan, there is difficulty in acquiring them because it is lender who carries more risks therefore the process of acquiring the loan is a thorough one. Besides that the interest rates are always high compared to secured types of loan.
Debt consolidation to me is a good idea in dealing with multiple types of debts. But that is me, after reading this article, it is up to you to decide whether or not you want to consolidate your debt and by which way.