How do you qualify for a debt consolidation loan

What You Need to Know About Debt Consolidation Loans?

When you have multiple loan payments, like credit card bills, car loans, home loans, or others, it becomes quite challenging to track the payments and outstanding bills. So, is there any strategy to overcome this challenge? Consolidation can be a good alternative.  
Debt consolidation means merging all your debts in one place. It is the process of paying multiple debts with a new loan. It provides flexibility for fixed, monthly payments. 

  1. It is advisable to consider debt consolidation if you get a loan at a lower interest rate. 
  2. It helps you reduce your debts and reorganize them in one place.
  3. Most debt consolidation loans provide fixed-rate installment loans.

How does a consolidation loan work? 

Debt consolidation merges all your debts into a new loan. It can lower the monthly payment, allow you to pay off your debts in a short time, and increase your credit score.  

Debt consolidation works in four basic steps:

  1. Determine all your current debts: It is a crucial step as it helps you understand how much debt you have and the monthly amount you pay against it. 

  2. Look for the time left for the last payment. If you are about to finish a debt sooner, you better not include the loan in consolidation. 

  3. Taking a new loan: After evaluating all your previous loans, opt for a new loan. While taking a new loan, always try to get a low-interest loan. This will help you save some money in the long term.  

  4. Use the new loan to pay off your debts. Pay all your previous debts. 

  5. Pay off the new loan: Pay off your new loan consistently; it will help your credit score as your credit utilization has decreased. 

Are consolidation loans cheaper?

Consolidation loans can be cheaper if you have a favorable credit score—the interest rates on debt consolidation range from 6% to 36%. You need an excellent credit score to get a loan at lower interest rates. 

Key things to look for in a debt consolidation loan 

If you are looking to refinance your debts, always consider a few things before taking a debt consolidation loan. 

  1. Type of loan: For debt consolidation loans, there are ample options available, like personal loans, 0% balance transfer credit cards, 401(k) loans, and home equity loans. Some require collateral, while others don’t. Evaluate all the areas that can impact your finances. 

  2. Loan term: Long-term loans mean paying more interest to the lender. And if you go for low monthly payments, you directly choose long-term repayment for your loan. It is good to have a shorter period despite having a high monthly payment because, eventually, you pay less interest on the loan.  

  3. Secured or unsecured loans: Secured loans mean you risk your assets against failing to pay the loan. The lender keeps your assets as collateral to secure their lending. Personal loans or 0 percent APR credit cards do not demand any collateral. 

 Here’s the thing! Secured loans offer lower interest rates than unsecured ones. 

What are the advantages and disadvantages of consolidating loans?  

Advantages of consolidating loans

  1. Accelerates debt payment: With debt consolidation, you are likely to pay more each month, which can result in quicker debt payments.

  2. Reduces interest expenses: With debt consolidation, if you find lower rates for the loans compared to the interest rate of combined current loans, you can save more on interest costs.  

  3. Easy monthly payments: It becomes a safer task to manage the monthly payments as they get merged into one. This reduces the chances of a missed payment. 

  4. Fixed-installment loans: Many debt consolidation loans are fixed-installment loans that assure you about your debt cycle. 

Disadvantages of consolidating loans

  1. Partial solution to financial issues: It is not the only solution to your financial problems.

  2. Additional fees: Some debt consolidation loans include originating fees, balance transfer fees, prepayment penalties, and annual fees. 

What should be avoided in consolidation loans? 

Not all consolidation loans work according to our requirements, so it is good to avoid a few to crack a great deal. 

  1. High-interest rate loans: The average rates for personal loans are around 11% to 14%. Some lenders can even offer the lowest rates at 3.99% if your credit score works in your favor. It is advisable to compare multiple lenders for the best rates. 

  2. High-fee loans: Some lenders that provide personal loans with lower interest may attach additional fees like originating fees, processing fees, etc. The fees can be as high as 10%, unnecessarily increasing your payment.

  3. 401(k) Loans: Taking money from your savings, like a 401(k), can put your financial future at risk. You end up paying taxes and penalties on the amount you borrowed. You may also reduce your future savings. 

Does debt consolidation hurt your credit score?

Taking a new loan to repay the current loan can negatively lower your credit score. Credit score: look for previous debts with regular payment histories.  
Whenever you opt for a new loan, it negatively impacts your credit score as it involves a credit inquiry. But in the long term, it may also help you increase your credit score. With regular monthly payments and a decreased credit utilization ratio, you can drastically increase your credit score.  

What is the current interest rate for a consolidation loan? 

The current interest rate may vary depending on the credit score and payment history. 

  1. Excellent credit score: 750-850. If you fall into the category of having an excellent credit score, you are most likely to get an interest rate of 14.15%. 

  2. Good credit score: 690-719. If you fall into this category, you may have loan consolidation at an interest rate of 16.49%. 

  3. Fair credit score: 630-689. Individuals with fair credit scores are most likely to have loans at 19.04%. 

  4. Bad credit score: 300–629 Individuals with the lowest credit score, i.e., below 500, may not qualify for the loan, and if they get the approval, they may have a 21.18% interest rate on the loan.

Conclusion

Debt consolidation is a strategy to compile all your debts in one place by refinancing your current debts. It is useful to reduce the duration of your debt cycle and the overall interest cost. It also helps you increase your credit score by decreasing your credit utilization. Before going for debt consolidation, always check for the lowest interest rates. 

Suggested Articles:

  1. Signature Loan Vs. Personal Loan

  2. How to get a loan for small business

  3. Business Loan Vs Personal Loan

07 Nov, 2023

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