How Debt Consolidation Loans Work

When you have multiple debts and loans to pay off (credit
card debt, personal loans, overdrafts, etc.), each carrying different interest
rates, monthly payment dates, and repayment duration, it is easy to get
overwhelmed. However, since the loans were obtained from different sources and
each came with its own terms, they can’t just be combined at will. To roll
multiple loans and debts together under a singular plan, you need to get a debt
consolidation loan. Unfortunately, many people don’t know how debt
consolidation loans work. With that in mind, the following should take some of
the mystery out of debt consolidation loans.

How it Works

A debt consolidation loan offers people who struggle to pay
off various high interest loans or credit cards with a unique opportunity combine
those loans and credit card debts under a new loan that carries a lower
interest rate; thereby, providing not only the convenience of a single payment instead
of multiple ones but also the potential for substantial savings in accrued
interest.

For example, if someone has 3 credit card debts with
interest rates ranging from 18% to 24% and an unsecured personal loan with an
interest rate of 29%, depending on the amounts on the credit cards and the
balance on the personal loan, the amount of money paid in interest alone can be
considerable. If the individual in this case is credit-worth, (i.e. a credit
score well above 700) and valuable collateral (real estate preferably), there
is an excellent chance to obtain a debt consolidation loan with an interest
rate below 10%. Again, the savings on interest alone can be substantial.

Banks and credit unions offer the best rates for debt
consolidation loans but as mentioned above, a healthy credit score and/or a
collateral is needed. Some other creditors offer debt consolidation loans to
people with average credit scores and collateral, but they charge very high
interest rates (up to 45%).

NOTE: Depending on the terms of their
initial loans and their credit score, some debtors may not need collateral to
get a debt consolidation loan from banks and credit unions.

Reasons to get a Debt Consolidation Loan – How Debt Consolidation Loans Work

• Lower interest rates
• By opting for a longer amortization period, monthly payments may be significantly reduced.
• It simplifies finances: a single loan is easier to manage than multiple loans.
• Unlike credit card debt, a debt consolidation loan removes the possibility of accumulating more debt.

The Right Time to Consolidate

The best time to apply for a debt consolidation loan is when
your credit score is high enough to qualify you for a lower interest rate. It
is also important to have a financial plan to ensure that you do not accumulate
debt again, along with an income that covers your monthly payment.

The Wrong Time to Consolidate – How Debt Consolidation Loans Work

Do not consolidate if:

• You have a low credit rating.
• Your debt exceeds 50% of your yearly income and you cannot pay it off in five years. In this case, debt relief may be a better alternative.
• The only options available come with high interest rates. If you consolidate your debt for an interest rate over 30% and you take over 5 years to pay it off, you effectively double the size of the loan.

In conclusion, a debt consolidation loan offers a way out of crippling debt. This opportunity should be taken with both hands: get better terms, choose a payment plan that works for you, and prepare a financial plan. Without a sound financial plan and the discipline to stick to the plan, the new and improved loan may not serve you well in the end.

This article originally appeared on AboutZenLife.com.

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