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What is a Debt Consolidation Loan?

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Dan Steadman

Financial Advisor, DCL

What is a Debt Consolidation Loan?

Household debt in the United States has reached record heights. Total household debt climbed to $12.73 trillion as early as the end of first quarter of 2017. This, for the record, is $50 billion higher than the worse marks reached during the 2008 financial crisis, according to a report by the Center for Microeconomic Data. Now that the US economy is starting to recuperate, Americans are slowly but surely gaining access to more credit once again.

As Americans currently enjoy this sense of freedom, however, household debt is skyrocketing and not showing signs of slowing down anytime soon. This creates obvious problems for the economy, irresponsible lending and borrowing are what began the financial crisis back in 2007. But on a more micro level, a large amount of debt has a profoundly crippling impact on an individual and their ability to progress in life.

Debt consolidation helps get people back on track – it’s a great way to alleviate the burdens of debt without doing serious damage to your credit score. The consolidation process involves paying off debt using finance and then repaying this finance at a much reduced rate than what was attached to your original debts. This page will give you all the tools you need to understand if debt consolidation is the right choice for you.

Why People Fall into Debt

The idea of borrowing money has always been an attractive option for most people. From cars, houses, consumer goods, and other items of luxury, consumers feel having these things are part of the “American Dream”. Lenders, on the other hand, have made it easier for anyone to live it.

Debt is a problem that is mainly symptomatic in modern culture. There have been numerous studies on how current financial products have helped increase the amount of debt that people undertake. For example, if you go to a restaurant and you have cash, you’re much less likely to spend more money than if you have a credit card. The psychology of not having the money directly in your hand (in the case of a credit card) makes it much more likely that you’ll spend bigger.

However, many of the reasons people fall into debt point to lack of skills in handling money. Most people never learned it in school anyway. Add that with a problematic mindset and lack of discipline, and you are on your way to being part of the latest debt statistic.

In some cases, debt is incurred by extraordinary events. Personal crises and unexpected expenses such as a medical emergency or unplanned house repairs can ruin one’s budget for the month. Most of the time, people rely on their credit card to make up for these unplanned-but-necessary expenses

Unfortunately, many consumers will have no idea that they are in way too deep in debt until it’s almost too late. It is only when they cannot keep up with their responsibilities that they realize they are in serious trouble. This results in a number of problems. Financial stress can create a range of difficulties in someone’s life and can eventually result in assets being seized. On top of this, a consumer’s credit score can be seriously damaged if they do not take care of their debt commitments in time. This can create future problems. If they act fast, they just might turn things around by getting a debt consolidation loan.

What is Debt Consolidation?

So, you may be wondering exactly what does debt consolidation mean? In simplest terms, debt consolidation takes all debts and combines them into a single loan with a single payment. Many people feel this option will give them more elbow room to ease their way out of their debt as they will only be making a single payment per month. But what do debt consolidation companies do? They also often refinance your debt when they consolidate it, which makes your payments much lower. For example, a debt consolidation company may give you loan to pay off all your current debt – you’re then responsible for paying them back the loan, most likely at a much lower interest rate than you were previously paying. But this isn’t the only way to consolidate debt, more information on various methods is provided below.

You may be wondering: what is the best way to consolidate debt? There are a few things to consider if one is inclined to make a debt consolidation loan. Most of the time, it depends on the individual’s credit score and nature of the credit. For example, if a consumer owns a home, he or she should start considering a home equity line of credit (HELOC) which utilizes the equity in a consumer’s home. This particular option looks at the consumer’s credit score and the amount of debt, which means the type of plan you are going to get depends on these two main factors.

Home refinance with cash out, on the other hand, is for consumers who still have a fair amount of equity in their property. The consumer then makes a new loan larger than the previous mortgage amount. He or she then uses the extra money to cover for the old debts.

Again, refinance with cash out puts consideration on the consumer’s credit score and amount of debt.

A third option that is popular among many consumers is a personal loan. Personal loans have become a viable option for paying old debts primarily because they incur generally less interest than credit cards and commonly have short loan terms. This is effectively the same as the loan discussed at the beginning of this section. Many banks and lenders offer personal loans that are specifically geared towards helping people refinance their debt.

The Hole

Many people view racking up debt as a temporary problem that can easily be escape. This is simply untrue – debt can create seriously problems for someone’s financial future. In fact, many people live their entire lives under the control of debt. The problem is that once someone enters a large amount of debt, they enter ‘the hole’. The hole is a system in which your debt dictates your future ability to accumulate wealth.

For example, let’s say that you rack up a large amount of credit card debt and you are unable to pay it off. You may be thinking that the best option is to default on the loan and try and start fresh. If you do default on the debt, a number of problems can emerge. Firstly, you may just end up getting back into credit card debt. Secondly, you may begin to find it hard to get any form of finance. In addition, if you are able to get a loan or another credit card, the interest rate that the lender will offer you will be much higher because your credit score will have been damaged by your previous default. This means that the debt or loan that you’re taking on will grow to be a larger burden because of the interest rate that you’ve been offered.

On top of this, because you have less access to credit, and the credit you do have access to comes at a high interest rate, you will be less able to take advantage of investment opportunities. This means that your ability to accumulate wealth is damaged in the long run. For all of these reason, it’s much better that you try and get out of ‘the hole’ as quick as possible – it will be much better for your future financial health.

The Advantages of a Debt Consolidation Loan

As mentioned, debt consolidation offers an advantageous opportunity for any borrower to settle their incurred debts. The one-payment-per-month-to-one-creditor scheme makes it easier for the borrower to keep track of their payments on top of dealing with a lower payment and interest rate. If you’re trying to decide if debt consolidation is right for you, it can sometimes be easier to look at things from a more concise perspective. Below is a full list of the benefits of consolidating your debt:

Reduced Number of Payments

With reduced number of payments, the borrower is saved from the stress and hassle of dealing with multiple creditors. This gives him/her more breathing room and reduce the chances of missing the payment due date, giving the borrower more time dealing with other pressing things in his/her life. Having multiple creditors can be an unnecessary stressor on someone who is unable to cope with a range of commitments.

Lower Payments

Aside from the outright advantage out shelling out less payments, seeking a loan consolidation can also allow the borrower and his/her family to get back on their feet and avoid committing the same mistake again. By consolidating your debt together your total monthly payments will be greatly reduced in most cases.

Lower Interest

With lower interest rates, any debtor can have ease off the burden of making heavy payments every month. Consumers should then make sure that they understand the terms of this new loan and they have full knowledge of what they will be paying on the proposed loan.

Getting Caught Up

If a borrower is constantly lagging behind his debts, a debt consolidation loan can help borrower catch up with other financial responsibilities. In some cases, a debt consolidation can allow the borrower to keep some extra cash and finally get ahead of his bills.

Getting Your Credit Score Back on Track

Once you begin paying off your debt, you will most likely see that your score improves in the long run. This is especially true because you will be paying off your credit card balances – credit cards tend to damage your credit score if you are carrying a high balance on the card. The more available credit that you use, the more your credit card will suffer. By taking out a consolidation loan and making on time payments, you will be putting yourself in a position to see your credit score rise to new heights.

Disadvantages of a Debt Consolidation Loan

As with anything, debt consolidation has its own “dangers” as well. Being out of the woods can be tempting for some if they don’t have a change of mindset on spending. Also, there always lies the risk of ending up paying more interest depending on the type of the loan you are getting.

Accumulating Credit Card Debt Again

While a debt consolidation loan promises to take the debt off your back, there is always the possibility of falling back in the debt hole once again if the borrower does not exercise discipline and self-control. Only those who have settled their debts through hard work and determination are unlikely to revert and wind up in debt again.

Those who take a debt consolidation loan and then maxing out their account’s credit find themselves in a worse situation than before. If they used their home equity to consolidate their debts and did a poor job of paying for the rest, they now have a bigger mortgage to pay and a lot to add their existing debt. These situations often put more things in their lives at risk.

Paying More in Interest

On rare occasions, borrowers actually end up paying more interest over the life of the loan. If a consumer chose a home equity line of credit or a home refinance, he/she is in for a 30-year term mortgage. This means, that even these options carry little interest, the length of the payment term makes the borrower pay more – maybe even more than the debt’s principal amount. This is why it is important to make sure you have a full understanding of the consolidation loan you’re getting – you should never end up paying more than what you’re currently paying.

Unchanged Spending Habits

Sometimes people just do not learn. Whether it’s because of their attitude or plain bad luck, some cases are not very inspiring. There are instances when the borrower becomes too relaxed and unworried that they end up going back to the habit of overspending and doing away with budgeting. With this attitude, the possibility of falling back in debt will be highly likely.

Short Term Credit Score Damage

So, what does debt consolidation do to your credit? In the advantages section, we mentioned that your credit score will improve in the long run if you consolidate your debt and make on time payments. This is true for responsible consolidators, but it must also be said that in the short term your credit will be damaged. This is because you are taking out an additional loan to refinance your current debt, credit bureaus will initially penalize you for taking our more debt to pay off others – as they do when you take out any new loan or credit card. But don’t let this deter you – in the long run, your credit will be much healthier.

Who Offers Consolidation?

So, after reading all of this you think that debt consolidation might be the right path for you. If this is the case, you’re just like the hundreds of thousands of Americans that have consolidated their debt in the past. While debt consolidation has grown in popularity in recent years, the concept itself has been around for ages. Many traditional lenders offer debt consolidation loans – there is a good chance that your consumer bank will be able to help you get one of these loans. But using a traditional lender can sometimes be time consuming – they require lengthy documentation and sometimes take weeks (or even months) to approve you.

If you need consolidation quickly, you’re much better using an online lender with a great reputation. Online lenders allow you to make instant applications – you can upload documents directly to the websites portal. In fact, online lenders are able to get you the capital you need much, much quicker. Sometimes within 24 hours! If you think that you want to start the process straight away, online lending can often be the best option.

Debt Consolidation Calculators

Before you decide if debt consolidation is right for you, head online and test the waters with a debt consolidation calculator. These calculators can help you see how much money you can save by using debt consolidation – there are plenty of free ones available if you do a Google search.

Head to some of the lenders that you are considering using and see what type of interest rates they offer for consolidation. Once you’ve done this, have a look at the current debt that you have and determine the interest rates that you’re paying. The calculators will allow you to put in interest rates, term times, and amount owed. You then put in the new interest rate that you will be using to consolidate. The calculator will provide you with analysis of the amount of money you can save by refinancing your debt. This is a great way to get a true understanding of the amount of money you will save if you refinance your current debt.

Those Unable to Qualify

Debt consolidation loans has seemingly become the borrower’s weapon of choice. However, with insufficient credit scores or unstable income, approval for a loan can prove to be difficult. The borrower, helpless and desperate, then sees that filing for bankruptcy is the only way out of this situation.

Bankruptcy is a very serious personal and financial decision. The implications of filing for bankruptcy ripples and stays on your record for a long time. In fact, the record of your bankruptcy will stay on your credit report for ten years. Within that period, you will have a hard time getting a mortgage if you don’t have one. You may lose some of your assets. The bankruptcy court can seize your property if it deems it ineligible for example. On top of that, you will no longer be allowed the use of any credit cards.

While bankruptcy seems to be the last option for borrowers who are in a serious amount of debt, it will not serve as a get-out-of-jail-free card. It does not relieve the borrower of all financial responsibilities.  For example, if a borrower/consumer is obligated to pay for child support or alimony, they must continue to do so even after filing for bankruptcy, and if he/she has as existing mortgage, that debt stays as well.

Another alternative will be to solicit the help of a debt relief company to help you get out of your debt problem. National Debt Relief works with borrowers to mediate and negotiate arrangements with their creditors. The NDR takes acts as an intermediary between the creditor and the borrower with the intention of communicating with credit companies to reach a reduced settlement amount. National Debt Relief helps consumers become debt free.

While the process of debt settlement does not happen in a breeze, and it will have some negative implications on your credit rating, it is an effective way of settling debt for borrowers who are stuck deep in debt. It’s really important that you don’t let your debt take over your life, debt consolidation is one way that you can take back control over the current chaos that may be causing your to make additional poor financial decisions.

Verdict

With any lender that you opt to work with, you should make sure to do adequate research into their business history – you don’t want to choose a lender that has a horrible customer service reputation. As with any form of finance, you need to make sure that there aren’t any hidden fees or charges. The best way to compare your different options is to ask lenders for a full cost of the loan at its maturity. You should also use a debt consolidation calculator to help you better understand the savings you may be able to make. Never use a debt consolidation loan that will end up costing you money – it may sound ridiculous, but it has happened to people in the past. Consider this an exciting time – you’re getting your life and credit score back on the right track!

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