What is Debt Consolidation ?

Debt consolidation can be defined as an unsecured personal loan that is taken to clear of many other loans. In other terms it is the replacement of multiple loans with a single loan. It is usually done to reduce the interest rates and have a fixed interest. It will generally have low monthly payment and the repayment period will belong.

Interest rate is the amount a borrower pays the lender for the use of money that he does not own and the lender receives it for compensating his consumption for lending it to the borrower. It is generally expressed as a percentage over a period of one year.

Similarly fixed interest is nothing but it is the interest that does not fluctuate over the term of the loan. Debt consolidation mostly involves a secured loan against a property that serves as a guarantee, which most commonly will be a house. This guarantee allows or is the reason for the low interest since by guaranteeing the house owner agrees to allow the forced sale of the house in order to repay the loan. Since the risk of the lender in this case is less, the interest offered is also low.

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Debt consolidation is very much useful when an individual is trying to clear his/her credit card debt. This is because the interest rate of credit cards is much higher than unsecured loan from a bank. If a person has a property or an asset such as house or car he/she may get a secured loan using the property as a guarantee. This will help in clearing the payment sooner with less interest rates. How to consolidate debt While consolidating the debt it should be noted that the main thing that an individual should focus on is the loan should be lower to all your overall costs. To do this there are two things to which are to be kept in mind. One is to get the interest at the lowest rate possible and the other is plan to repay all the debts taken within a period of about 3-5 years. The best way to do this are included and explained below in brief: • Home equity loans. • Debt settlement. • Using credit cards. • Traditional debt consolidation loans. • Cash out refinance. • Rapid repayment. • Credit counseling. • Retirement loans.
Home equity loans: With this kind of loan the amount borrowed is the difference between the value of the home and any other mortgages. This is of two types: • Home equity line of credit. • Home equity loan. Home equity line of credit: Here the amount is borrowed up to a pre-approved credit limit i.e. where the interest rates are variable and can borrow more if the money is still available. Home equity loan: It is a fixed amount of money for fixed term. The above mentioned can give low interest rate with interest usually tax deductible. Debt settlement: This is another option, which is helpful in clearing the debts soon. Here a regular monthly payment is made to the settlement company rather than paying the bills. The negotiation company will settle the balances usually for about fifty percent or less and the creditors will contact them instead of you regarding the payments. The disadvantage is that this method is not safe since the credit rating may be affected in short run and the company which a person is dealing must be a reputed on or there are chances of loosing all the money paid. Using credit cards: In advantage of this method is that if a person has a good credit rating, he/she can get much lower rate compared to any other form of consolidation loans. The credit card issuers also do not require a collateral and they are far from risks. It is better to go for a fixed rate from the issuer at a lower rate and plan the repayment period within three to five years. Traditional debt consolidation loans: This type of loan is an unsecured personal loan and the collateral offered to the lender is you only. Since the loans given are risky and not easy to get back the lenders take the security as the person itself. In this case if the rate of interest is too high and the term of repayment is long i.e. around ten to fifteen years, then it is not worth going for it. But if the rate of interest and the term is feasible then this is a good method to save the money in the end. Cash out Refinance: Cash out Refinance is defined as refinancing the home and taking out money to pay off the bills. Here if the interest rates are low then the money remaining during the monthly payment can be invested in something such as retirement fund. Rapid repayment: This can be done by first choosing a fixed level of monthly payment and getting committed to it every month. First the highest rate debt is paid and the remaining is paid with minimum amount.
Credit counselling: In this method a person will make one monthly payment to the counselling agency and the agency will pay for all the creditors. The agency may not consolidate the debt instead they will you to get out of all your debts. This method does not affect the credit rating and will help you come out of the debt within three to six years maximum. The disadvantage or drawback rather in this method is that if the agency pays the bills late you will be responsible to pay the price since you are still responsible for that debt to the lender. Retirement loans: In this method a person can borrow against a retirement account instead of withdrawing it early so that he/she need not have to pay taxes and penalty. These loans are given at low interest rates and the interest is pain to the person since he/she is the lender.

Procedures of debt consolidation loans
• One single payment is made on behalf of many other payments. This helps in managing the finances easily.
• Since one payment is made versus many and the rate of interest is low, the amount that has to be paid per month is reduced.
• The common type of debt consolidation is the home equity loan, the interest rates will be much lower since home is the collateral and if any problem comes in the payment they can take the home.
• The interest paid to a mortgage can be used as tax write-off whereas the interest paid to a credit card cannot be done like that.
• With this procedure you will be dealing with only one agency or creditor. So if any problem arises you need to make a single call than many and controlling the finances are much easier.

Conditions of debt consolidation loans
• Consolidation loans are secured loans i.e. there will be a collateral which in most cases is a home. If the payment is not made there are chances of the home being taken away by the creditors. But in case of credit card, if the payment is not made, you may have a bad rating but the home is secured since the loan is an unsecured loan.
• With credit cards it is easy to get into further debts since the load is easy to bear and there will money left at the end of the month to spend.
• Most of the mortgages range from ten to thirty year term. Instead of spending few years to get out of credit card these mortgages makes you spend the length of the mortgage getting out of the debt.
• Though the interest rates are less, if the term of the loan is long say some thirty years then you may spend more than you would have if the individual loan were kept.

Article Contributed By: Shilpa V


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