If your outstanding debts and liabilities are bothering you, it may be a good time to opt for debt consolidation.
Consolidating your debts means integrating them into a single loan, also called the debt consolidation loan.
By doing this, you no longer have to deal with multiple lenders and can instead shift your focus to just a single loan that needs to be paid off.
However, you would do well to learn all the pros and cons of debt consolidation before blindly joining the bandwagon. This way, you can ensure that you address all your debts properly and timely without taking too many risks.
Pros of debt consolidation
Outstanding debt can not only be a serious concern for an individual, but it can also contribute to a larger economic impact.
For example, the total consumer debt in Canada reached a staggering $2.2 trillion, consisting of student loans, credit cards, car loans, and mortgages.
For an individual fending off an array of different debts, debt consolidation can have several positive aspects. They include:
1. Lowering of interest rate
Depending on your credit score since other loan applications, your overall interest rate may be lower than your previous outstanding loans.
Lower interest rates may enable you to save more money over the loan’s lifespan. However, to get the best offers, it is important to look around and find a lender with an established prequalification process for personal loans.
Although, it may be important to remember that not all loans have the same interest rates. For example, student loans have a significantly lower interest rate than other loans such as credit cards.
A single debt consolidation loan can have lower interest rates than some loans but higher than others. So, it’s important to know which loan you are focusing on.
2. Faster paying off
If your integrated debt consolidation loan involves a lower interest than the individual loans, you may consider paying off extra with the saved money.
This may help save even more on interest by paying off the loan sooner and shortening the loan’s lifespan. However, most debt consolidation loans have a longer loan term, so you must focus on paying the loan off significantly earlier.
3. Monthly payment reduction
Since debt consolidation loans have an extended lifespan, your overall monthly payments become significantly lower because the remittance amount is spread out over an extended period.
However, this may mean you pay substantially more over a longer-term, even if it simplifies monthly budgeting.
4. Credit score improvement
Applying for a debt consolidation loan improves an applicant’s credit score.
However, borrowers may experience a temporary dip in credit score as debt consolidation loans generate several hard credit inquiries.
As an example, your credit utilization rate may reduce faster than on your credit report. This happens as you successfully pay off credit cards and other lines of credit.
Moreover, in due course of paying off debt consolidation loans, making on-time and consistent payments can also boost your credit score.
5. Streamlining of finances
For many people, the most significant benefit of opting for a debt consolidation loan is reducing the total number of payments. This also reduces complexities as there is only one interest rate to take care of every month.
The possibilities of reduced expense, faster loan pay-off, and improved credit scores all contribute to streamlining your finances. Moreover, you also have a better idea of when you can achieve your goals of being completely debt-free – if that’s what you are aiming at.
The other side of debt consolidation
Undoubtedly, there are several benefits if you leverage debt consolidation effectively and in a risk-free manner. Having said that, there are some associated risks and fallouts you should be aware of.
1. Overall higher interest payment
Upon successful consolidation of your debts, the timeline for repayment commences immediately and extends further down. And even though your monthly interest rates are substantially lower, you may have to pay for a more extended period meaning that you end up paying a lot more on interest payments.
2. Risk of missed payment
If you end up missing any of the scheduled payments on your consolidated loan, your credit score may take a severe hit, even subjecting you to additional fines and payments. It is critical to review your budget to ensure you stay on top of payments and don’t miss any.
Tools like autopay and other scheduled payment mechanisms can help you stay updated. Another important aspect is to communicate with your lender if you are about to miss a scheduled payment.
3. Interest rate uncertainty
The interest rate for your debt consolidation loan depends entirely on your current credit score. Getting a lower interest rate is, of course, great news. However, if your credit score does not make the cut, you may pay a substantially higher interest rate. Eventually, your total expenses may include origination fees along with a higher interest over the loan tenure.
4. Incurring additional costs
When looking for a debt consolidation loan, you must understand all extra associated fees and expenses. Often, there are many charges like annual fees, closing costs, balance transfer fees, and origination fees that significantly raise the total amount you end up paying.
5. Irregular addressing of financial issues
Finally, even though debt consolidation simplifies your payment scheme and makes your life easier, it does not change your financial habits. Until and unless you become a responsible spender, you shall continue to pile on debts, and to consolidate them would not be too helpful. That is why cultivating healthy financial habits is a must to be completely debt-free and manage your finances better.
Conclusion
As the discussion shows, consolidation of your outstanding debts may be instrumental in removing excessive liabilities from your life. However, you must be cautious and prudent while opting for debt consolidation, just like you would for any financial plans and projects.
Knowing all the pros and cons allows you to make an informed judgment and stay risk-free in your path to rid yourself of financial burdens.
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