Credit consolidation loans or debt consolidation loans primarily involve taking out one loan to pay off all your existing loans in one fell swoop. This allows an individual to streamline their credit and manage their debt much more efficiently. However credit consolidation loans are a serious long term credit commitment so you should be absolutely sure that you can afford the repayments.
Credit consolidation loans operate by a credit company analysing your credit problems and then basically buying your debt from you, thereby “taking it off your hands.” The debt still exists but the third party acts as an intermediary, thereby relieving you of the need to manage your debts by yourself.
Knowing when to choose a credit consolidation loan over other types of payment is incredibly important as in many cases there are better options to alleviate your credit problems.
A credit consolidation loan is suitable for an individual who
- Is struggling or failing to meet regular monthly debt repayments.
- Has a variety of debts with different levels of interest on each.
- Wants to pay a lower overall rate of interest
- Wants to keep their credit rating healthy or quickly rejuvenate their bad credit ratings.
- Is secure enough in their finances that once their debt is under control they can guarantee to make the new monthly repayments
The key benefits of credit consolidation loans are;
- One single monthly repayment
- Reduction in outgoings
- Streamlining of debt allowing individuals to avoid hassle from multiple creditors.
- Reduced interest rates
- Clearing your existing debts and keeping up your payments helps increase your credit rating
- Can often be integrated with forms of debt settlement.
The key disadvantages of credit consolidation loans are;
- Greatly extended repayment period – typically ten plus years – meaning you will find it harder to qualify for new credit during that period.
- There is no guarantee that you will be able to tie all of your outstanding debts into one credit consolidation loan – meaning you may still have one or more high interest credit lines to pay off.
- Alterations in the terms and conditions of your previous creditor’s policies can arbitrarily alter your debt consolidation plan.
- It can often be difficult to get an unsecured consolidation loan with a bad credit rating unless you have collateral that can be sold to make up 100% of the loan should you fail to make repayments.
- You run the risk of exacerbating your debt problems if you continue to have to spend beyond your means.
There are two central types of credit consolidation loans – unsecured and secured. The latter of these is the most common so we shall examine it first.
Secured credit consolidation loan
A secured credit consolidation loan is a loan that is guaranteed by an asset which acts as collateral should you fail to make repayments. These are the most common credit consolidation loans owing to the low credit ratings most individuals with credit problems face.
Secured credit consolidation is therefore suitable for homeowners or people with other valuable assets; but you must have financial stability otherwise you risk losing your collateral. Typically secured loans will have lower interest rates than your existing debts and will substantially reduce your outgoing payments/month. Typically the repayment period will be between 10 and 25 years so you need to fully understand that this is a long term credit policy.
Unsecured credit consolidation loans
Unsecured credit consolidation loans are simply a reduction in the number of loans you have into one monthly payment. They are not guaranteed against any collateral. Due to this you will likely pay a much higher overall interest than if you were paying the individual loans.
Unsecured credit consolidation loans are therefore suitable if you need to reduce your monthly outgoings but have no tenable assets to use as collateral. However whilst your monthly payments and interest rates will be substantially lower you will end up paying a lot more over a greatly extended period of time – meaning you are unlikely to be out of debt for decades to come.
This gives you a good indication of the cost benefit analysis you need to undertake before opting for any credit consolidation strategy. However one last thing to bear in mind is that many companies will undertake debt negotiation with your creditors alongside the debt consolidation loan.
This is one of the ways in which the credit consolidation loan companies make money as they can write off part of your debt to creditors. They do so by guaranteeing full payment of the remaining debt after your debt consolidation policy is in place. What consumers should bear in mind is that they can often reap the benefits of these negotiations as companies will pass on a portion of their savings to you as a means of enticing you into a policy with them.
For instance if the debt company manages to write off 10% of your outstanding debts they may offer to pass on half of that saving to you, in exchange for your custom. This means that a careful consumer can potentially end up paying a lot less than they would have had to without the debt consolidation. So ensure that you shop around carefully to decide which credit consolidation loan is going to be the most beneficial for you.
Nevertheless it is worth re-iterating that debt consolidation is a very serious debt relief option. You will be making repayments for years to come and jeopardising your long term financial stability by having to take out a policy against your home or a policy that will stay with you for up to quarter of a century.
