Refer to the meaning taken from www. investopedia.com debt consolidation means taking out a new loan to pay off a number of liabilities and consumer debts, generally unsecured one. In effect, multiple debts are combined into a single, larger piece of debt, usually with more favorable payoff terms: a lower interest rate, lower monthly payment or both. Consumers can use debt consolidation as a tool to deal with student loan debt, credit card debt and other types of debt.
With debt consolidation, you get a single loan to pay off all of your smaller loans, thereby leaving you with just one monthly payment rather than several. The theory is that one payment will be easier to manage. The goal is to lower the interest rate and the monthly payment while paying off your debt more quickly.
However, before you choose a debt consolidation loan to think about anything that might happen in the future which could stop you from keeping up with repayments. For example, what if interest rates go up or you fall ill or lose your job?
If you can’t stop spending on credit cards, for example, because you’re using them to pay household bills, this is a sign of problem debt. You should get free debt advice before taking out a debt consolidation loan.
Also, always think about the potential downside of a secured loan. Your circumstances might change and your home could be at risk if you can’t keep up with repayments. According to note adapted from, www.moneyadviceservice.org.uk, consolidating debts only makes sense if:
- Any savings are not wiped out by fees and charges.
- You can afford to keep up payments until the loan is repaid.
- You use it as an opportunity to cut your spending and get back on track.
- You end up paying less interest than you were paying before and the total amount payable is less (it could be more if you repay over a longer period).
Two types of Debt Consolidation Loans
As stated at https://loans.usnews.com, there are two types of debt consolidation loans: secured and unsecured. The primary difference between the two is that secured debt consolidation loans use collateral, while unsecured loans do not. Unsecured loans are more common, but you can use a secured loan for unsecured debt, such as a home equity loan used for credit card debt consolidation.
Secured debt consolidation loans.
Secured debt consolidation loans are typically available at brick-and-mortar financial institutions, including banks and credit unions. They use collateral, such as home equity used to secure a home equity loan, and generally have better interest rates than unsecured ones. If you have the collateral and can meet the requirements, a secured loan may save you money on interest as you pay down your debt.
Home equity debt consolidation loans, a type of secured debt consolidation loan, offer a fixed interest rate. Interest paid on a home equity loan is usually tax deductible, while credit card interest is not. However, home equity loans for debt consolidation can be risky, as your home may be foreclosed on if you can’t pay your loan. “The danger is if you eat up a significant part of your home equity,” says Gerri Detweiler, education director of business credit website Nav.com. “Make sure you have plenty of cushions in there so if something happens and you had to sell your home, or you had to move … you don’t end up losing your home.”
Repayment terms can be 10 years or longer, and if the value of your home drops during that period, you may owe more than your home is worth. If you’re facing bankruptcy, credit card debt is unsecured and typically discharged more easily than a home equity loan.
Unsecured debt consolidation loans.
Unsecured debt consolidation loans don’t require collateral, and they usually have easier approval requirements than secured debt consolidation loans. Unsecured debt consolidation loans can have income requirements as low as $24,000 annually, debt-to-income ratios of up to 50 percent and minimum FICO credit scores as low as 600.
Unsecured debt consolidation loans are offered online through banks and marketplace lenders. This makes applying for a loan convenient, and some providers offer instant approval online, so you can find out right away if a loan is going to work for you.
While unsecured debt consolidation loans can be easier to obtain and more convenient than secured debt consolidation loans, they generally have higher interest rates, so they are more expensive to pay down than a secured debt consolidation loan.