The Basics of Consolidating a Debt

February 1, 2023

What is Debt Consolidation?

Debt consolidation refers to the act of using credit card or one loan to repay multiple credit cards or loans in order to make the process of repayment easier. When you have one balance rather than multiple, it becomes easier to pay off debts as well as reach an agreement of a more favorable terms such as lower interest rate, lower monthly payment, or both with your lender. Basically you combine the multiple debts you have and pay them off in a single monthly payment. 

Who Should Opt for Debt Consolidation?

Debt consolidation is commonly a sensible solution for people who are overburdened with large credit card debts. You can do this with or without a loan. If you qualify for a low enough interest rate, then you should opt for debt consolidation.

How Does it Work?

If you are facing different types of debt, you can apply for a loan to pay off other debts and liabilities. That loan will be consolidated into a single liability. The new payment method would consider the debts as a single entity and you will continue to pay until the debt is returned in full amount. 

The first step of debt consolidation is to apply at your bank, credit card company, or credit union. Here, having a good history and relationship with the financial institution would go a long way. Even if that doesn’t work out, you can seek lenders, online loans, or private mortgage companies to entertain your request.

Now, why would a creditor help consolidate your debt? It makes sense that a single monthly payment and lower interest rates increases the probability of the debt paying off. The collection of debt becomes easier and more likely.

Pros of Debt Consolidation

There are many possible benefits of consolidating your debts. Here are some:

It is easier to manage your finances when you have a single monthly payment to make rather than multiple different ones

Consolidating debt opens the possibility of lower interest rates

It could also lead to a reduction in overall monthly debt payments

Cons of Debt Consolidation

However, it does come with its own share of drawbacks. Such as:

One of the goals of debt consolidation is lowering the interest rates from the ones applied to your existing debt. Unfortunately, you may not qualify for an interest rate that is lower than your existing balances

If you stretch out the repayment time, you may end up paying even more in interest despite having a lower rate

Applying for a secured loan will require you to put down a collateral such as a house or a car or other financial assets

Types of Debt Consolidation

Debt consolidation can be broadly classified into two types; secured and unsecured loans.

Secured loans are the ones that require the applicant to put down a collateral such as a house or a car, which is a back-up source of money for the lender in case you fail to repay the loan.

On the other hand, unsecure loans do not have a collateral prerequisite but have higher interest rates.