Debt Consolidation- Is It An End All Solution to All Your Debt Woes?

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Debt Consolidation is often touted a one-stop solution to all your debt woes. Education loan, personal loan, and student loans, you may be labouring under the burden of all these different loans. It is sometimes very difficult to track and make the different loan repayments and principal payments along with juggling your work responsibilities. Debt consolidation may seem an easier option where all these different types of loans are consolidated into a single, large debt consolidation loan. Single Debt (SD) is a credit counselling agency that helps you consolidate different types of unsecured debt like personal loans, student loans and the high interest credit card debt into a single manageable debt. This helps you to streamline your finances, negotiate better interest rates and manage your debt.

How does a debt consolidation loan work?

Doing a Debt Consolidation loan is a three-step process consisting of rolling all the total volume of old debts into one, replace old loans by a new debt consolidation loan and pay off the new loan. Sounds very easy on paper, doesn’t it?

Debt Consolidation loans work in the following circumstances:

There are no underlying financial challenges.
That you have a good credit score and credit standing in the market.
Your credit stands up to rigorous scrutiny.
It is a good idea for consolidating unsecured debt.

Is Debt Consolidation A Good Idea?

If you have several high interest loans, combined with a good credit score, then debt consolidation may be a good idea. A good credit score enables you to qualify for a lower interest rate. Otherwise doing a debt consolidation doesn’t make sense. If you tend to overspend and assume more debt, then a debt consolidation doesn’t make sense. For instance, if you do a debt consolidation and go on assuming more credit card debt, then the debt consolidation becomes a vestigial process.

Some reasons why you should avoid debt consolidation include the following:

There are significant risks and tradeoffs with this strategy:

Upfront Costs: The process of debt consolidation includes new, upfront costs like origination fees, balance transfer fees, closing costs and annual fees. When taking your decision to consolidate your debt, make sure that you factor in all such additional fees and costs. These entail the true costs of debt consolidation and must not be missed in your reckoning before you sign on the dotted line.
Low Credit Scores: You may be among those who are financially indisciplined and not have a good credit score, As the very purpose of doing a debt consolidation loan is to enjoy low interest rates, low credit scores will mean your interest rates will remain stubbornly high. You may also end up with interest rates which are higher than your current average interest rates. This plus higher front-end costs will mean higher overall charges. All individuals with poor credit histories and high debt levels may even end up paying higher rates of interest which negates any saving benefit from lower interest rates.
Higher Absolute Interest: You will pay higher absolute amount of interest after consolidating all your loans over time. Payment of interest starts from day one and may extend up to 7 years in total. Monthly instalments may be lower but interest payments will extend for a longer period. If you make large loan instalments payments every month, you can reduce your future payables. A prolonged payment period will mean that your other financial goals like saving and wealth accumulation may be delayed further.
Missed Loan Payments: Any missed loan payment means a major issue in terms of your deteriorating credit score. This may also mean added fees. You can of course avoid such situations by using autopay. Doing this means you do not need payment reminders. Make sure that you communicate any missed payment to your lender/loan originator promptly.
Financial Prudence: Debt Management requires a large amount of financial prudence and discipline. You may fiscally imprudent and liable to spend large amounts without adherence to your budgets. Debt Consolidation does not make you financially prudent or practice fiscal restraint. It only restructures your debt into a more manageable form. After all, remember that it is your spending habits that got you into debt. Accumulating more debt like new credit cards and personal debt will push you further into indebtedness. If you miss a single instalment payment, your lending institution will report you to the credit bureaus. This will make it difficult for you to qualify for future loans.
Risk of losing collateral: You may have secured loans like home equity loans which are secured by a lien of your home which is mortgaged. Under debt consolidation, where you miss making some instalment payments, you run the risk of losing the title to your home upon default.
False Sense of Financial Relief: Debt Consolidation creates a false sense of financial relief. When faced with a single loan instead of a multitude of loans, you may feel that your debt burdens have lifted. Without changing your spending behaviour and financial prudence, debt consolidation cannot succeed. You must address the root cause of debt accumulation.
Limited Access to future credit: Consolidating all your debts by closing old loans and taking on a larger new loan will adversely affect the future availability of credit. You may be able to access credit only on less favourable terms than before.

Some Alternatives to Debt Consolidation Loans

Here are some alternatives to debt consolidation:

Debt Snowball Method: In this method, you start paying off debts from smallest to the largest irrespective of the interest rate. The idea is to gain momentum and motivation as you pay off smaller debts first, then tackle larger ones.

Debt Avalanche Method: Unlike the snowball method, the avalanche method prioritizes paying off debts with the highest interest rates first, potentially saving you money on interest payments in the long run.

Debt Management Plan (DMP): A DMP is a program offered by credit counseling agencies. They negotiate with creditors on your behalf to lower interest rates or waive fees, and you make a single monthly payment to the agency, which then distributes the funds to your creditors.

Balance Transfer: With a balance transfer, you move high-interest debt from one or more credit cards to another credit card with a lower interest rate, often with a promotional period of 0% interest. This can save you money on interest if you can pay off the debt within the promotional period.

Home Equity Loan or Line of Credit: If you own a home, you may be able to borrow against the equity you have built up through a home equity loan or line of credit. These typically have lower interest rates than unsecured loans, but they put your home at risk if you’re unable to make payments.

Personal Loan: You can take out a personal loan from a bank, credit union, or online lender to consolidate your debts. Personal loans typically have fixed interest rates and terms, allowing you to know exactly how much you need to pay each month.

Debt Settlement: In debt settlement, you negotiate with your creditors to accept less than your outstanding loan balance. While this can help you get out of debt faster, it can also negatively impact your credit score and result in tax consequences for the forgiven debt.

Conclusion

While debt consolidation loans can offer relief from overwhelming debt burdens, it’s essential to weigh the potential drawbacks before pursuing this option. From extended repayment periods and higher interest rates to the risk of accumulating more debt and losing valuable assets, there are several factors to consider. Individuals considering debt consolidation should carefully evaluate their financial situation, explore alternative options, and seek guidance from financial professionals to make informed decisions about managing their debts.

Ultimately, the key to successful debt consolidation lies in addressing the root causes of debt accumulation and adopting responsible financial habits for long-term financial stability. It’s essential to carefully consider the terms of any consolidation offer and to explore other options, such as budgeting, negotiating with creditors, or seeking credit counseling, before making a decision. Single Debt is at your disposal to provide credit counselling services including dealing with creditors and recovery agents and facilitate consolidating all your debt and create a more manageable debt management solution. Contact us today if you are struggling with the management of several unsecured loans and want to enjoy freedom from financial stress.