What is debt consolidation and how does it work? If you’re looking for debt consolidation answers, look no further.
Debt consolidation can be confusing to understand, but it is essentially a way to consolidate several loans into one loan.
Continue reading below to learn everything there is to know about debt consolidation and whether it is the right solution for you.
9 Debt Consolidation FAQs You Need To Know
In this article:
- What does Debt Consolidation Mean?
- How does Debt Consolidation Work?
- Is Debt Consolidation Free?
- What do Debt Consolidation Companies Do?
- Will Debt Consolidation Affect my Credit?
- Can you Cancel Debt Consolidation?
- Can I do Debt Consolidation Myself?
- Debt Consolidation Pros and Cons
- Is Debt Consolidation Right for Me?
1. What does Debt Consolidation Mean?
In debt consolidation, borrowers take out a single loan to pay off multiple but smaller loans. These smaller loans are usually unsecured debts which include credit card debts, student loans, and car loans.
The two major types of debt consolidation loans are secured and unsecured.
In secured loans, borrowers offer collateral to back up their loan. Collateral is a property owned by the borrower such as a car or a house.
Unsecured loans, on the other hand, are the opposite. These loans do not have collateral. Thus, they are more difficult to get. Moreover, they usually have higher interest rates and lower qualifying amount of loan.
But, the interest rate on an unsecured loan is still less than that of a credit card.
2. How does Debt Consolidation Work?
In debt consolidation, you take a big loan to pay for several smaller loans of the same kind.
So instead of paying several different loans every month, you only have to think about paying for your new consolidation loan. It saves you the trouble of making separate payments every month.
What’s more, borrowers usually are able to get a more favorable payoff term for their debt consolidation loan.
However, bear in mind that you can only consolidate similar type of loans. You cannot consolidate your credit card and car debts.
3. Is Debt Consolidation Free?
Debt consolidation rates and fees vary from company to company. So technically, it isn’t free as you will still have to shell out money.
Here’s a list of the different kinds of debt consolidation fees and charges you may encounter:
- Origination fees – applicable to new loans; usually 1% to 5% of the total amount of your loan
- Closing fees – another term for origination fees
- Balance transfer fees – applicable when you do a balance transfer; usually 3-5% of your total balance
- Annual fees – applicable to home equity line of credit (HELOC) or home equity loans or and balance transfers; usually around $50
- Late fees – will depend on the type of your debt consolidation; $15 to $35 for normal credit cards; at least $100 for balance transfers
- Early cancellation fees – $400 to $500 flat fee for HELOC; 1% of your loan amount within the first three years
- Interest charges – 7 %to 30% for debt consolidation loan from banks and other lenders, but it can be 20% if you have a good credit score; 4% to 10% for HELOC
4. What do Debt Consolidation Companies Do?
Debt consolidation companies review your income and debts, as well as credit scores.
If they deem you qualify for a debt consolidation loan, the terms will be discussed with you. This includes the interest rate, repayment period, and monthly payment.
Once they issue a check, use this to pay off individual debts of the same kind. Therefore, borrowers now owe only one monthly payment which is to the debt consolidation company.
5. Will Debt Consolidation Affect my Credit?
Consolidation credit card loans with high balances with an installment loan may actually be good for your credit rating. Especially if the loan is to pay off credit cards that are near their limits.
However, it’s worth noting that taking any new loan can still cause a short-term drop in your credit score.
6. Can you Cancel Debt Consolidation?
Borrowers can cancel their debt consolidation loan acquired from a financial institution.
However, this will be a hard hit on your credit score. All fees from your debt consolidation company will have to be paid first.
So payment for your existing debts will not be prioritized and may be defaulted. Therefore, make sure you know the risks a debt consolidation loan entails before applying for one.
7. Can I do Debt Consolidation Myself?
You can do debt consolidation by yourself in five easy steps:
- Improve and control your spending habits first.
- Assess your financial situation, most especially your debts. Make a list of all your existing debts including its creditor, amount owed, interest rate, and type of debt. Make sure to prioritize debts with the highest interest rates like credit cards.
- Never underestimate negotiating with your lenders. Use this to lower your payments and interest rates. You can even negotiate for a different payment term.
- Instead of borrowing money from financial institutions, find ways to improve your income. Accept part-time and freelance jobs if you have a spare time, or sell things you do not use and need. Use this extra money to pay off loans beginning with the highest interest rates.
- With the first four steps, hopefully, you were able to eliminate some of your high interest loans. But if not, at least you were able to consolidate them into much lower interest loans. The last step is to follow the debt snowball method. Pay debts with the smallest balances first. Once it is paid off, proceed to the slightly larger one and pay it off. Do this until you finish paying off all existing debts.
8. Debt Consolidation Pros and Cons
Before you apply for one, check out the pros and cons of debt consolidation.
- Convenience; you no longer have to worry about paying multiple loans since you will only be paying one single loan every month
- Lower interest rates
- Better payment terms, for some
- Improve credit score
- Avoid stress caused by collection calls from your creditors
- Watch out for scams by some “debt consolidation companies” which offer monthly payments and interests that are too low
- Longer repayment terms
- If you backed up your loans with your assets as collateral, these can be at risk
- Can be expensive, depending on your debt consolidation company
9. Is Debt Consolidation Right for Me?
Different people have different needs and are in different financial situations. Therefore, debt consolidation is not for everyone.
It entails risk, fees, and potentially longer repayment terms.
But if you are looking for a convenient and less stressful way to pay off your current debts, then debt consolidation may be for you.
Watch this video from Michael Bovee and find out the pros and cons of debt consolidation:
If you’re struggling to pay your debts, perhaps you should consider debt consolidation. However, like any other debt management plan, it has risks and fees.
Therefore, it’s important to assess your financial situation first and research debt consolidation companies. Hopefully, these debt consolidation FAQs were able to help you in some way.
Do you have more debt consolidation FAQs to share? Share it with us in the comments below!