Does the Debt Consolidation Loan Really Help in Managing Your Dues?
November 2, 2021 Mutual Fund
These days people generally have the quick and easy access to credit facilities, as a result many people fall into a debt trap by taking multiple loans that become a struggle to repay it. A debt trap is a situation when you are constantly in a cash crunch and are forced to take new loans to manage your expenses, existing loans or credit card dues. If you are in a debt trap then you owe multiple dues to the multiple lenders that can create a financial burden on you.
Debt Consolidation is an act of taking out a new loan to pay the multiple debts. Many finance experts advise opting for a Debt Consolidation Loan. It helps you to manage your debt and lower your financial burden. Debt Consolidation Loan is refinancing your existing debt obligations. So it’s basically let you take a new loan to combine all your existing loans for better terms, such as lower rate of interest, longer loan tenure, etc.
Consolidating all your loans, can decrease your interest costs which is going to help you to pay the loan quickly It helps you repay your existing multiple small loans by taking one large loan with favourable loan terms. An individual can have several loans running, such as an educational loan, personal loan, credit card dues, etc. By availing of a debt consolidation loan, you can pay off these existing loans and continue with a single loan. The most important benefits of consolidating your debts are – you have only one Loan to pay EMIs for and you usually have to pay lower rate of interest as compared to your existing loans.
Personal Loan for Debt Consolidation:
In India, a Personal Loan is the most popular way of availing of a debt consolidation loan. When you apply for a Personal Loan for Debt Consolidation, the lender checks your credit score and debt-to-income ratio to calculate the eligible loan amount. With personal loan you can consolidate all your loans into one and can manage your EMIs with lower rate of interest.
Secured Loan for Debt Consolidation:
Availing of a Secured Loan for Debt Consolidation is a good idea to consolidate all your unsecured loans and credit card dues. It is more convenient to get rid of multiple loans. Since these loans are backed up by security, the rate of interest is comparatively lower than personal loans. Although these loans are not promoted directly in the name of debt consolidation, you can take a Loan Against Property, Home Refinancing, Cash on Car, etc. to pay off your existing dues.
To know whether the Debt Consolidation Loan will work for you or not, let’s know the benefits and disadvantages of it. Please note that since most lender in India offer an unsecured debt consolidation loan, we will consider the same for further discussion.
What are the benefits of availing of a Debt Consolidation Loan?
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Easy to Manage:
As the debt consolidation loan combines all your unsecured loans, you do not have to worry about the due dates of multiple existing loans. You have only one loan to repay, which makes it easy to remember the EMI due date. This ensures that you do not miss the repayment, which ultimately helps you to maintain/improve your credit score.
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Lower Rate of Interest:
Debt consolidation usually offers a lower rate of interest than your existing unsecured loan. However, the rate of interest on this loan can be higher than some loans like an educational loan, home loan, etc. Therefore, it is advisable to avail of a debt consolidation loan when your existing loans are high-interest loans. This can reduce your financial burden and help you come out of a debt trap earlier.
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More Savings:
When you pay lower rate of interest on a debt consolidation loan and the cost of the loan is comparatively lower, then you can save more money which you otherwise would have paid on your high-cost loans. This amount can be used to repay your debt consolidation loan faster by opting for pre-payment. Since the debt consolidation loans are offered for a longer tenure, it is necessary to repay them as soon as possible as longer loan tenure means you have to pay more on interest. However, before opting for pre-payment, make sure you check with your lender about the pre-payment terms and conditions as different lenders have different loan terms.
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Helps to Improve Your Credit Score:
Too many loans and credit card dues can negatively impact your credit score. Whereas, timely repayments of a single loan help you instantly improve your credit score. However, make sure you do not fail to timely repay the loan instalments or default on a loan.
What are the disadvantages of a Debt Consolidation Loan?
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Cost of a New Loan:
Whenever you take a new loan or transfer the existing loans, the new lender charges you with a processing fee or balance transfer fee. Apart from that, you might have to pay your existing lender with the foreclosure charges as per the terms of the loan agreement. If these extra costs are too high, it will not serve the purpose of consolidating your debts. Therefore, it is advisable to calculate the exact cost-benefits before applying for a debt consolidation loan. If there are no foreclosure charges on your existing loan and the new lender is offering lower processing fee or balance transfer fee along with a lower rate of interest, which in turn saves a substantial amount, only then it makes a sense to avail of a debt consolidation loan.
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Floating Interest Rate:
Your credit score is one of the major factors that decide your rate of interest on the debt consolidation loan. If you do not have a good credit score, you might not be offered an attractive interest rates by lenders. Moreover, most lenders offer debt consolidation loans on a floating rate of interest. This means that the lender can change the rate of interest in the future with changes in economic or as per company policies.
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Longer Loan Tenure:
The debt consolidation loan makes your EMIs affordable by increasing the loan tenure. It can be beneficial to many borrowers as your monthly expenses decrease. However, the longer loan period means you will have to pay the interest for a longer duration. This ultimately increases your total loan outgo and you end up paying more on interest even if the new rate of interest is lower. Therefore, it is essential to repay the debt consolidation loan as early as possible to save the interest amount.
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Might Lead to Creating More Debt:
A debt consolidation loan helps you manage your debts in a better way, but it does not help you to change your overspending and binge lending habits. If you do not have any control over your spending, knowing that you have only one debt with affordable EMIs might make you take more loans. This can be avoided by investing in Systematic Investment Plans (SIPs) or bank recurring deposits, which will be a compulsory savings that can be used to repay the loan earlier or for any emergency requirements.
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Missing Payments Will Damage Your Credit Score:
As you have only one loan that affects your credit score, it will severely damage your credit score if you miss an EMI or delay the payment. Furthermore, delayed payments will attract heavy late payment charges. Therefore, before applying for a debt consolidation loan, it is advisable to check whether the amount of EMI is affordable to you for a longer loan term.
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Not Suitable for All the Loans:
If you have a very small loan amount due or you are reaching the end of your loan tenure, then it does not make sense to do all the hassle if it is not going to save a substantial amount. Also, if you are already paying a lower rate of interest on your existing loans, in that case the lender might not be able to offer you lower rate of interest than what you are already paying.
Who should avail for a Debt Consolidation Loan?
A debt consolidation loan can be an ideal for you under the following circumstances:
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If you are paying multiple unsecured loans and credit card dues at a high rate of interest and want to save more money by reducing the interest rate.
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If your credit score has improved since you availed of your existing loans.
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If you want to manage your debts better with a single EMI.
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If you think you can repay the loan early by saving more on the interest amount by changing your habits of overspending and binge lending.
Are there any alternatives to a Debt Consolidation Loan?
If you want to avail of a debt consolidation loan, which is an unsecured loan, but you are not eligible for it or are unable to find any better deals, then you can look for other options that can act as a debt consolidation loan. The best alternative to a debt consolidation loan is a Loan Against Property. You can avail of a Loan Against Property to pay off your existing unsecured loans and credit card dues. The rate of interest on the Loan Against Property is much lower than unsecured loans. Moreover, since the loan is backed up by a property, the lenders do not dig your credit history and credit score much. Hence, you get instant loan approval if the property meets the requirements and you have a sufficient credit score. However, if you fail to pay a few EMIs or default the loan, the lender holds the right to sell your property to recover the dues.
To Conclude:
A debt consolidation loan is an excellent way to combine all your unsecured loans and credit card dues under one roof. It helps you to manage and organise all your debts. Although the lenders generally offer a lower rate of interest and extend loan tenure on a debt consolidation loan, it is necessary to repay it as soon as possible to avoid paying a hefty amount on interest. Carefully read the points mentioned above to check whether it is the right kind of loan for you or not. It is advisable that before applying for a debt consolidation loan, compare the different loans of different lenders to get the best deal and avoid any future disputes. Moreover, to come out of a debt trap it is essential that you timely repay all the dues. Try to limit your spending and do not take more loans after you have availed of a debt consolidation loan.
This article first appeared on PersonalFN here
