What is a Debt Consolidation Loan?

A debt consolidation loan is basically a loan that lets you cover your various debts (credit cards, medical bills, and others).

Folks normally apply for such a loan for the following reasons:

  1. Avoid the hassle of having to pay many lenders
  2. Save time by not having to track and manage several different interest rates

But the biggest reason of all is that many expect to be able to pay lower interest rates than the effective combined rate that is currently being paid on all outstanding loans.

It is reasonable to expect that in the current economic climate where high interest rates are prevalent, doing a little bit of work researching ways in which we can reduce our loan obligations is the right thing to do.

Advantages of taking out a debt consolidation loan

Let's briefly examine the pros and benefits:

  • potential to save on monthly interest payments
  • enjoy savings measuring in the hundreds of dollars every month
  • streamlines the payment process - one cheque made out monthly, rather than several

    • Cons / Dangers / Disadvantages:

    Will you get a lower rate?
    - depends on your credit score, FICO being one of the most widely used among lenders
    - 14% to 15% if you have great credit, or if secured against collateral like your house
    - 18% to 21% if your credit is bad, since you are perceived as a risky lender

    Secured Debt Consolidation Loans
    - Banks want to know which of your assets can be used as collateral
    - Almost always, your home
    - Your home will come under the banks ownership, and possibly be sold off or liquidated if you end up being unabale to pay the loan

    Unsecured Debt Consolidation Loans
    - The exact opposite of the secured loan
    - You don't have to put up your home or other assets as collateral
    - Expect to pay a much more every month since these loans come with higher interest rate

    What to look out for when comparing debt consolidation loans?
    - length or tenure of the loan
    - what fees are levied
    - any hidden charges eg penalty on early settlement
    - monthly payments amount
    - cost of add-ons or enhancement options
    - impact on your credit score - ensure that taking on the loan doesn't further damage your credit score
    - fixed or floating interest rate

    The online way for comparing lenders
    - Getting free online debt consolidation quotes
    - There are several sites that offer quote comparison services, many of them are free
    - Should be the first step in your search
    - Convenient
    - Remember that the one offering the lowest rates isn't necessarily the best
    - Don't be shy to set up as many appointments as you can handle, then srutinize their T&Cs
    - Get solid advice from forums

    Where to obtain debt consolidation loans?
    - Credit Unions tend to be more lenient than banks

    Summary:

    Debt consolidation loans, if managed wisely, is yet another useful tool to manage your finances. Interest rates on such loans are often lower than what is charged for credit cards, so you effectively get to pay off the loan much sooner, and at a lower monthly cost.

    Like any other financial management tool or method, you have to be highly disciplined in its use, otherwise you might sink further into debt.