How Does Debt Consolidation Work?

When you are neck-deep in debts, even a single piece of advice can help you keep your head above the water. So, you might have read or heard about different methods that offer relief from debt, like debt consolidation, balancing, debt transfer, and debt settlement. But unfortunately, each can be as confusing as it can get.

We’ll focus on debt consolidation and break it down for you bit by bit.

What Is Debt Consolidation?

Typically, debt consolidation is merging multiple debts into a single debt that can be paid off with a streamlined monthly payment.

How Does Debt Consolidation Work?

In debt consolidation, a borrower applies for a new, single loan and uses that money to pay off the other debts.

Consolidating your debts means you will have to pay comparatively small interest rates to a single lender instead of high-interest rates to multiple ones. It’s an effective method for individuals who struggle with controlling finances.

The process goes as follows:

  • You apply for a debt consolidation loan.
  • The lender analyzes your credit score and debt-to-income ratio.
  • You submit documentation proof of your debt, finances, identity, mortgage, insurance, etc.
  • The lender evaluates the documentation to decide on giving the loan.

If you succeed in getting the loan, you’ll now be in debt to a single lender.

Types of Debt Consolidation

There are two main categories of debt consolidation:

  • Secured Loan – When you opt for a secured loan, you’ll have to put one of your valuable assets as collateral. This collateral is usually your home or car. Doing this means you may have to attend to your lending company coming after your property or car in case of missed payments. However, going for a secured loan ensures less interest rate.

  • Unsecured Loan – This type of loan doesn’t demand any collateral. As a result, your lender will charge higher interest rates to cover as a backup.

This type of loan doesn’t demand any collateral. As a result, your lender will charge higher interest rates to cover as a backup.

Credit Card Balance Transfer

This type of debt consolidation works when you have multiple credit cards. So, you move the existing debts from all the credit cards to a single, new one.

As the debt consolidation process works, you will have to make a single payment from your new card. However, acquiring this type of loan comes with a significant transfer fee. Moreover, it depends on your credit score and the type of credit card you qualify for to obtain lower interest rates.

It's crucial to keep a few things in mind before deciding if a credit card balance transfer will suit you best. These include:

  • Available interest rates
  • Applicable transfer fees
  • Applicable transfer fees
  • Consequences of missed payments

HELOC

A home equity loan involves putting your home as collateral. As it’s a secured loan, you can acquire lump sum money to pay off other debts or consolidate the existing debts into one.

With a HELOC, you’ll be obliged to pay interest on the entire loan amount you give, but the interest rate will be lower than an unsecured loan.

Student Loan Consolidation

Students often have to apply for multiple federal student loans to finance their college fees. Student loan consolidation is the best way to combine those multiple federal loans into a single, government-funded loan. This way, graduates can benefit from Public Service Loan Forgiveness and other advantages like lowered and simplified monthly payments.

Please note that student loan consolidation only works for federal loans. So, if you have applied for private loans, student refinancing debt consolidation will be the right choice to consolidate your private debt.

Should You Consolidate Your Loans?

For people struggling with controlling their spending habits and looking for a way to pay off their debts effectively, debt consolidation can work wonders. Keeping this in mind, it’s a good idea to consolidate your loans if:

  • You are focused on controlling your expenditure
  • You want to reduce the number of monthly payments
  • You have a better credit history to qualify for low interests
  • Your current income is sufficient to cover debt payments along with other bills

The Final Word

Debt consolidation doesn’t work magically to eradicate your financial troubles, but it’s certainly a good start to help you get on track with effective debt management. However, consider connecting with an expert credit counselor if you’re facing challenges.

Debt Free Life Inc counselors are one call away to guide you toward the right path!