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Consolidating debt into one loan is a strategy applicable to many types of debt both secured and unsecured. Other service options are restrictive in the type of debt that they can assist with.
Here we discuss consolidating debts in general by means of a new or existing loan. For information about consolidating debt from cards see: Consolidating Credit Card Debt.
Consolidating debt by means of a loan simply transfers the debt to a new creditor. You still have debt, but now the terms should be more favorable. The purpose of consolidating debt is to cut down on the cost of the debt by taking advantage of a lower interest rate loan.
Cutting down on the cost of debt can mean two things:
- Cut down the cost of your Monthly Repayment each month - when compared to the original monthly repayment/s.
- Cut down the Absolute Total Cost of Debt - how much you have paid by the time the loan is finally paid off. This is the original amount borrowed (or principal) plus all the interest that is charged over the life or duration of the loan.
Consolidating debt into a new loan can have different results, for example:
1. A lower Monthly Repayment and a lower Absolute Total Cost of Debt.
2. A lower Monthly Repayment and an INCREASED Absolute Total Cost of Debt.
3. A Monthly Repayment that is the same as before - but now for a lower Absolute Total Cost of Debt.
4. An INCREASED monthly repayment and (much) lower Absolute Total Cost of Debt. (Debt paid off fastest).
Consolidating debt requires that you first ask and consider, what is your goal in consolidating debt? Is it to obtain the lowest possible Monthly Repayment? This often comes at the expense of an increased Absolute Total Cost of Debt. Is your goal for consolidating debt to get the debt paid off as fast as possible? This requires making the largest repayment that you can safely and sensibly afford without risking default. The goal might be a compromise.
The Absolute Total Cost of Debt is affected by the loan duration. Other things equal, the longer the loan the greater the total interest payments and Absolute Total Cost of Debt.
Consolidating Debt - Factors To Consider
Factors impacting loan offers:
- Your current Income.
- Your Credit Score /history.
- Your availability of Collateral (affects your choices).
- Your Debt to Income Ratio (should affect lenders assessment, and your decision about debt consolidating).
Credit score affects the interest rate and availability of a loan. Debt consolidating loans are offered based on risk. Consolidating debt with bad credit normally equals higher interest rates, increased fees and lack of provider choice.
Balance: How much debt do you have for consolidating; your outstanding current debt balance owed?
Interest Rate: What is the interest rate payable on the current debt for consolidating?
Monthly Payment: What is the existing monthly payment on the current debt?
Duration: What is the existing loan duration? or how long do you have to payback the debt?
Total Cost: What is the absolute total cost or total interest payable on the current debt at the end of its term?
Early Repayment Penalty: Is there a charge for paying off your current debt early?
!Tip Get these figures for our Debt Consolidation Calculator
Balance: Current debt balance.
- What if any lump sum do you have that can be used to pay down the original balance before consolidating debt.
Interest Rate: On the new consolidating debt loan.
- What is the interest rate on the new proposed loan or any existing line of credit to be used?
- Is the interest rate fixed. Is there any variable rate. Is there any introductory rate.
Monthly Payment: What is your desired monthly payment?
- What will the new monthly payment be?
Duration: What is the proposed loan length?
Total Cost: What is the absolute total cost with the new proposed loan?
Fees: What Fee/s are involved with the Loan Application and Origination?
- Are there any Hidden Fees revealed in the small print? (e.g. late payment fee).
- Is there an Early Repayment Penalty with the new loan?
Type: Is the new loan Secured or Unsecured? (What type is the current debt?)
APR and Fees?
The Interest Rate is the cost of borrowing or the cost of the loan. APR (Annual Percentage Rate of interest) is the best way to compare the costs of loans. Be aware, with any interest rate quote - look to find the actual % APR.
In general, the lower the APR figure the better, but remember - sometimes a low APR comes with a high Absolute Total Cost Of Debt, because of a long loan duration. Fees may or may not be included in an APR quote. Think/ask are the fees with any proposed loan additional to the APR interest rate? Fees add to the cost of a loan, and if not already contained within APR, should be factored into the decision.
- How good is your credit score today?
- Have you approached the existing creditor about better terms?
- Can you improve terms by agreeing to a direct debit or electronic payment?
- What is your general financial situation?
- Can you afford to make the monthly payment for the duration after consolidating your debt?
- Have you compared loans and shopped for the best?
- Have you read about the specific product called a Debt Consolidation Loan
- Do you know about other types of Debt Consolidation Loans
- Have you considered alternatives to a loan? (liquidate savings/investments, sell items)
- Are you doing this as part of a wider strategy? Success requires a budget overhaul: How To Get Out Of Debt
Is consolidating debt a good idea? Consolidating debts through a new loan can be an effective strategy and your best debts solution. Consolidating debts via a loan can potentially lead to significant savings on the cost of debt. However, the approach is not appropriate or viable in every situation. The first thing required is a good understanding about consolidation loans and the alternatives, including pros and cons. Next there should be a thorough comparison of existing and proposed loan terms. Researching products and comparing is an important step. Carefully selecting the right lender is also very important. Consolidating debt without ruining credit may be achieved via a loan. We have explained how you should be aware of the absolute total cost of debt and loan duration whenever attracted to a particularly low monthly payment. The major criticism of loans as a method for dealing with debt is the same alarm sounded over any debt solution; the following is true:
As a way to debt freedom, consolidating debt fails if you carry on to spend all the savings achieved, and do not perform consolidation as part of a wider debt action plan. Consolidating debt is a method to lessen the debt cost burden. It is an approach designed to address the effects of debt. The act of consolidating debt does not deal with the reason behind or cause of the debt. No solution or alternative is a quick fix. Consolidating debt is about better managing the financial burden of debt at the same time as you perform a budget overhaul.