Debt consolidation is a form of refinancing, where you combine several loans and liabilities into one loan. Practically, multiple debts are combined into a single, larger debt, usually with more favorable payoff terms. A payoff term is considered beneficial if it has a lower interest rate, lower monthly payment or both. Consumers can compile various loans like student loan debt, credit card debt and other types of debt under the debt consolidation.
How to Consolidate
Various means can be applied to consolidate a consumer’s lump debts into a single payment.
- A new credit card can be used to consolidate all the previous credit card payments into one—which can be a good idea if the card charges little or no interest for a period. They may also utilize an existing credit card’s balance transfer feature.
- Home loan payments are another form of consolidation sought. Usually, the interest for this type of loan is deductible for taxpayers who itemize their deductions.
Debt consolidation is a means of financial formation to pay off other debts. Certain specific measures called debt consolidation loans are offered by creditors as part of a payment plan to borrowers who have difficulty in managing the payment of their outstanding debts.
Creditors are prepared to do this for the reasons that it maximizes the likelihood of collecting from a debtor. The debt consolidation loans are generally offered by financial institutions, such as banks and NBFCs.
2 basic types of debt consolidation loans:
- Secured loans are backed by an asset of the borrower’s, such as a house or property which works as collateral for the loan.
- Unsecured loans such as debt consolidation loans are not backed by assets and can be more difficult to obtain. They also tend to have higher interest rates and lower qualifying amounts.
With either type of loan, the interest rates are still typically lower than the rates charged on credit cards. Also, in most cases, the rates are fixed—meaning they do not vary over the repayment period.
Ways to consolidate your debt
There are 4 ways you can consolidate debt depending on your credit and savings:
- Balance transfer credit cards — Some credit cards, called balance transfer cards, offer introductory periods when they charge low or no interest on balances that you transfer to the card within a set period of time. This gives you an opening to save on interest and make more progress paying off your debt.
- Personal loans — If you can get a personal loan with a lower interest rate, you can pay off your higher-interest credit card balances, which may allow you to pay off your debt faster.
- Retirement account loans — You may take a loan from your retirement account to merge and pay off debt. Just be careful to pay it back according to the retirement plan’s rules or you may face taxes and penalties.
- Home equity loan or line of credit – With a home loan owners of a home who have an ownership stake in their home can take out a loan using their home as collateral. These loans usually offer lower interest rates compared to credit cards or personal loans. But be careful, that If you don’t pay it back, you could lose your home.
Advantages of Debt Consolidation Loans
Debt consolidation loans are beneficial for people who-
- Have multiple debts and owe more than Rs 3.5 -5 lakhs
- Receive frequent calls or letters from collection agencies
- Have accounts with high-interest rates or EMIs
- They are unable to negotiate lower interest rates on loans.
- Unsecured debt consolidation loans may not be tax-deductible. But if your consolidation loan is secured with an asset, however, you may qualify for a tax deduction.
The debt consolidation loans don’t erase the original debt, instead, they simply transfer all your loans to a different lender or type of loan where you might be paying lesser interest but within a limited timeframe.