Multiple creditors and payments become too difficult to keep track of, resulting in a creditworthiness deterioration. A debt consolidation loan comes in handy in these situations. It aids in the consolidation of numerous smaller loans by paying them off with a single new loan.
What is a Debt Consolidation Loan?
A debt consolidation approach allows a person to pay off several liabilities, such as several smaller loans, credit card bills, overdraft amounts, and so on, with a new, more favorable loan (lower interest rate, lower monthly payments, or both).
Types of Debt Consolidation Loans
- Secured loan: These loans are protected against collateral such as real estate, vehicle, gold, insurance policy, equity, etc. which can be easily converted to cash. A secured loan can be used to combine several unsecured debts.
- Unsecured loan: An unsecured loan is not secured against collateral and is solely issued basis the credit history and CIBIL score of a person.
Eligibility and Process of Debt Consolidation Loans
A bank, financial institution, credit card company or a credit union can issue a debt consolidation loan to a person who meets the below eligibility criteria:
- Age of the person should be 21 to 60 years
- The monthly salary of the candidate should be at least ₹15,000. However, this varies per bank, city, and other factors
- Applicant must be residing in the city of application since a year
- Applicant should hold a minimum working experience of 2 years
- All documents should be fair, true and duly submitted. The types of documents include – address proof, ID proof, bank statement, salary proof, etc.
- A person must have a good CIBIL score – ideally 620 above, though some exceptions can be made by lenders here
Process of Debt Consolidation Loan
Applying for a debt consolidation loan is simple if one meets the eligibility. The process includes:
- Analyzing the official website of institutions offering debt consolidation loans
- Conducting a comparative analysis based on interest rates, payment terms, etc. and selecting the ideal one
- Filling the form and applying for the loan from the chosen lender
- Submitting all necessary documents required
- Upon loan approval, the sum is deposited in the bank account to be used by the borrower for the said purpose.
Overall, it appears as an attractive financial move, though it must be opted for with utmost caution and after deep analysis of all advantages and disadvantages.
Benefits of a debt consolidation loan
If you’re looking to save money, streamline your monthly payments and circle the payoff date on your calendar, then debt consolidation may be a good fit. Here’s a breakdown of the main benefits:
- Pay down debt quicker. Making the minimum payment on your credit cards can stretch your repayment timeline for years. A debt consolidation loan may put you on a faster track to paying it off.
- Save on interest costs. Generally, if you qualify for a lower rate than what you’re paying now, you’ll save on interest costs. As of early August 2022, the average credit card interest rate was 17.58 percent, compared to the average personal loan rate of 10.60 percent.
- Simplify your monthly payments. It’s easier to manage one monthly payment than multiple payments with different due dates. This reduces your chances of missing payments, which is good for your credit.
- Repay on a fixed schedule. Many debt consolidation loans are fixed installment loans, which means you’ll know exactly when you’ll be debt-free. This can help motivate you while you pay down debt.
Risks of a debt consolidation loan
Before moving forward, you’ll need to weigh your immediate needs with your long-term goals. Some people choose to consolidate debt to save money and organize their monthly payments, but there are downsides:
- It won’t solve all your financial issues. Once you use the debt consolidation loan to pay off your debt, you might be tempted to start using your credit cards again. This increases your overall debt, which can impact your credit and make it harder to pay down your balances.
- There may be some upfront costs. Some debt consolidation loans come with fees, including origination fees, balance transfer fees, prepayment penalties, annual fees and more. Before taking out the loan, ask the lender whether any apply.
- You may pay more in interest. This might happen in two ways. Depending on your credit score, debt-to-income ratio and loan amount, you might pay a higher interest rate than you would on the original debt. Or, if you use the debt consolidation loan to lower your monthly payments by stretching out your repayment term, you may end up paying more in interest in the long run.
How to apply for a debt consolidation loan
There’s a little legwork involved, but taking these steps will be worth it if it saves you money:
- Understand your finances. A strong credit score gives you a better chance of qualifying for a debt consolidation loan and getting a good interest rate. Check your credit score before applying to see if it needs work.
- Compare lender terms. Shopping around for the best deal can help you save money on debt consolidation. Get quotes from multiple lenders and compare the interest rates, feess, loan terms and monthly payments. The loan with the lowest interest rate doesn’t necessarily mean it’s the best option. You could find that you’ll pay far more in fees for the loan with the lower interest rate than you would if you choose the lender that charges more in interest but fewer fees.
- Get prequalified. Some lenders offer prequalification, which gives you a sneak peek of the offers you may receive. Many can perform a soft credit pull, which means the prequalification won’t affect your credit score. You can generally get started online and check your rate by providing your name, physical address, email address, phone number, date of birth, Social Security number, housing and income information, and desired loan amount.
- Gather what you need to apply. When applying for a debt consolidation loan, you’ll need the information you used to get prequalified and documentation to prove your income. This could include your recent pay stubs, bank statements or tax returns (if you’re self-employed). Some lenders also request additional information, so it’s worth inquiring about documentation requirements before applying.
Once you’re approved, the lender may disburse your loan proceeds to your creditors or send the funds to you. Make sure the original debt is paid off, then work on your new loan. Set up automatic payments or use reminders to make on-time payments every month. Over time, you’ll be debt-free.