Many of us are consumed by debt. It may be the result of redundancy, increasingly high prices or simply over-spending.
At the end of each month, we make payments on credit cards, store cards and car loans, leaving little money to actually live off.
The idea of consolidating debt can seem like a good one. But how does it work and what are the real costs and benefits?
What is a debt consolidation loan?
This is the process of taking out one single loan and using the money to pay off all the other loans you have.
You then pay back the consolidated loan in installments over a set term.
You clear your store, credit and car debt in one swoop, leaving you with one loan amount and payment to make at the end of each month.
It sounds great, but if a consolidated loan came without issues everyone with lots of debt would have one.
For debt consolidation to be a good idea, certain circumstances need to be in place.
When is debt consolidation a good idea?
There are three main advantages of consolidating debt.
Getting out of debt
Firstly, there’s the relief of “clearing” your debt. You no longer feel swamped beneath monthly bills.
But it’s essential to remember that you haven’t actually cleared the debt – you’ve simply transferred it to another lender.
For the consolidated loan to be beneficial you need to change your spending habits and stop spending altogether on your credit and store cards.
You must have a plan to prevent running up debt again.
Making one payment
If you were juggling bills and sometimes failing to make the minimum payment on your cards, then one bill at the end of the month can be logistically easier.
Again, you mustn’t make the mistake of thinking debt has gone – it’s simply been consolidated.
Usually, a consolidated loan offers a smaller payment each month, but the loan runs for longer, so you can actually end up paying more.
Paying less interest
If your credit rating is good, you may qualify for a low-interest consolidation loan.
For example, if you have three credit cards with interest rates ranging from 18.99% to 24.99%, you may qualify for a loan that is, for example, 15%.
Remember to consider all the costs and the time frame of a consolidation loan.
If it takes longer to repay than your original short-term loans, you’ll end up paying more in the long run.
When is debt consolidation a bad idea?
Consolidating debt is not always a good idea. Consider these situations first.
Do you have bad spending habits?
By clearing credit and store cards, consolidation can make more money available to you.
It doesn’t address the excessive spending habits that may have created your debt in the first place.
Be honest with yourself. Are you going to march back into stores and load up more debt?
If this is you, a consolidation loan could be the biggest financial mistake of your life. You’ll end up with even more debt.
When costs are too high
If you don’t qualify for a consolidation loan with favourable interest rates, you’ll simply end up paying the same amount over a longer term.
Before consolidating debt, make sure you understand all the costs, how much and how long you’ll be paying for.
If the terms are no better than what you’re paying on your existing debt or your debt load is relatively small, you may as well bite the bullet.
If, by scrimping and saving, you can pay it off within six months to a year then don’t bother with a consolidation loan.
If a bank asks for collateral
If your credit rating is poor some institutions will ask for collateral before giving you a consolidated loan, such as your house.
Your home is at risk if you fail to make payments on a secured consolidated loan. Is this a risk you are willing to take?
What are sensible ways to consolidate debt?
There are other ways to consolidate debt without taking out a consolidation loan that are worth considering:
- a personal loan
- extending your home loan
- working out a debt-management plan with the help of a professional
- withdrawing from retirement or other savings
- using a 0% balance transfer credit card – as long as you can pay off the transferred debt during the 0% period.
How does a debt consolidation loan affect your credit score?
Taking out a consolidation loan should not affect your credit score. Failing to pay outstanding debt will.
Securing a loan from lamna
Need extra funds to pay off debt?
At lamna, we offer fast, discreet loans against the value of a wide range of assets, including high-value and luxury collectibles. For more information about using an asset to secure a short-term loan, contact us on 086 111 2866 or simply complete and submit our online application form.
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