Debt Consolidation Loan
The act of consolidating your debt refers to combining all of your debts into one place, so that you are not making payments each month to different creditors. With a debt consolidation loan, you would first need to find a lender to pay off all of your debts. You would then be responsible for making payments each month to only that specific lender until the entire loan is paid in full. These loans will often come from a financial institution such as a bank, but can also come from a family member or close friend.
Beware of easy lenders
Although there are many lending institutions that offer loans, it is VERY important to be selective about where you get yours from. A good consolidation loan will be offered to you at an interest rate (APR) that is at least 5-10% LOWER than the interest rate of your other debts. This will allow you to save money and pay down your debts faster.
Remember, not every consolidation loan is created equal! It is absolutely crucial to verify the annual interest rate, as some lenders will offer loans for as much as 29% APR or higher. If the interest rate of a consolidation loan being offered to you is higher than 14% APR, then you should consider how many years it will take you to pay off the loan (this information should be written in your loan agreement), and compare it to the amount of time it would take to complete another debt solution and rebuild your credit after.
A high-interest consolidation loan may seem like immediate relief; however, it could cost you hundreds to thousands of dollars more in interest, potentially taking years longer for you to become debt-free. Be sure to find out exactly how much you will be paying back after all interest is added to the loan (the principle plus interest), and how many years it will take you to pay it all back (the repayment terms).
Where to get a consolidation loan?
We recommend speaking with your bank or trusted financial institution first to see if you qualify for a debt consolidation loan. Loans for low-risk customers are currently being offered at around 7% to 12% APR. Therefore, it is important to have good credit when seeking a debt consolidation loan. If your credit is less than good, or your income is not high enough, the lender may require you to have a co-signer to get the loan. Your bank or financial institution may also require collateral before approving you for this type of loan. As mentioned above, if you do not qualify for a low-interest consolidation loan, it may be worthwhile to explore other debt relief options as well.
Another source for obtaining a consolidation loan can be a close family member or friend. This process can be much easier than being subjected to approval from a financial institution. However, this idea should be approached with caution. Make sure that the repayment terms are fair for both parties, including the interest rate being charged and the payment amount due each month. It is also a good idea to put the terms in writing in order to avoid disputes over the loan later on.
Regardless of what type of consolidation loan you choose, be sure to move forward with your mission to becoming debt-free by NOT racking up more debt on the accounts (for example, credit cards) that you recently paid off with the loan. Some financial institutions will require you to close your existing credit accounts before paying them off. However, if you do keep these accounts open, be sure to practice sound financial discipline and avoid accumulating new debt.
Impact on credit rating
Overall, a typical debt consolidation loan from a financial institution such as a bank or credit union will usually improve your credit report and credit score. This is due to the structured payments that you make each month being reported to the credit bureaus. It can also bring down your utilization ratio, which is the amount of debt that you are carrying compared to the amount you actually have available to use. This will have a positive effect on your credit score.
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