Debt Consolidation – Frequently Asked Questions

It is perfectly possible for a person to live a debt-free life. You just need to know how to get rid of debt affordably and with the lowest possible risk of default. Debt consolidation is an effective strategy, as long as it is used correctly. You certainly have a lot of questions about it and its use. Here you will find the answers which you are looking for.

1. When is debt consolidation not recommended?

This option of dealing away with debt will not help if you cannot afford to make the monthly payments on the new loan. If you have lost all or a considerable chunk of your income or if your expenses have increased considerably, you may not be able to repay the new loan. In this situation, a credit counsellor will suggest the best course of action.

It is also not recommended that you take out extra cash in addition to the amount necessary for repaying previous debt. This option is often available when a property is used as collateral for a debt consolidation loan. Taking out more money can get you into more debt and the risk of you losing your house will be higher. You should try to borrow as little as possible.

2. What is a consolidation loan exactly?

This is a loan which is used for the repayment of previous debt. All outstanding balances are cleared and the borrower is left with just this loan. The consolidation loan could be unsecured or secured with specific collateral which is usually a property. Most often, the loan has lower interest rate compared to the loans and credit cards which are repaid with it.

3. What are the benefits of using this loan?

All previous debt is cleared so you can have a fresh start. You will have to pay only a single instalment every month and this will lower the risk of missed or late payments due to confusion about deadlines. Usually, the monthly payment is smaller and this makes the new loan more affordable to repay. Often, the interest rate is lower as well and this will save you money. The fact that you have got a new loan does not mean that you have got rid of debt completely, however. You will have to be disciplined and committed to making the payments on the new loan.

4. What is secured debt consolidation?

This option is by far the most popular one. You will use a home equity loan also known as a second mortgage to repay all your existing debt. The new loan is secured with your house and this will automatically make its interest rate lower compared to any rate on a credit card or an unsecured personal loan. The interest rate is typically fixed. The new loan should be easier to repay, but you have to be absolutely disciplined as otherwise you risk losing your house.

5. How to consolidate personal loans effectively?

The first thing which you need to do is to go over the outstanding balances on your current loans and credit cards. Check how much money you owe in total. Then check the interest rate on each loan or credit line. This will give you an idea of what to look for when searching for consolidation loans. You should compare as many products from different lenders as possible. Your goal is to identify the loan with lowest interest rate. Just remember to check the fees and other costs as well. Make sure that the monthly payment matches your budget.

6. How do you apply for a consolidation loan?

You have to fill out an application form and submit a set of relevant documents along with it. Most lenders will require bank account statements and pay slips for several months' back plus proof of address. The lender will run a thorough credit check on you so it makes sense to work on improving your credit score before you make an application.

7. How are student loans consolidated?

You should contact all lenders that have extended a student loan to you and check whether they can be consolidated. If you can find different offers, you should compare the interest rates and cost. The interest rate on the new loan must be lower than the average rate on your existing loans in order for you to make smaller monthly payments and to save money. You have to have sufficient income to pay the monthly instalments and to have good credit history and credit score in order to qualify for a student consolidation loan.

8. How does debt consolidation affect your credit score?

Applying for a debt consolidation loan and taking out one will not have a negative impact on your credit score. Quite the opposite, it may have a positive impact since you will clear all outstanding balances on personal loans and credit cards. However, if you want to maintain your score and make it higher, you have to make the payments on the new loan timely and in full every month. Additionally, you should use your credit cards wisely.

9. What are the good and bad sides of debt consolidation?

There are not really good and bad sides. It all depends on how you go about it. You have to ensure that you will get the lowest possible interest and monthly payment. The new loan must be perfectly affordable to you. You should have sufficient income left to pay the monthly instalments after covering your other monthly expenses. You have to be disciplined about repaying the loan.

10. How common is debt consolidation?

Generally, this is considered last resort for debt repayment as in most cases the new loan has to be backed with an asset such as your house. At the same time, many people are struggling with the repayment of their personal loans and credit cards so they go for this option. It can work excellently, if used correctly.

You can now decide whether debt consolidation is the right option for you. Consider your current position and your future plans to make the right choice.

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