Debt consolidation is a form of debt refinancing that entails taking out one loan to pay off many others. This commonly refers to a personal finance process of individuals addressing high consumer debt but occasionally refers to a country’s fiscal approach to corporate debt or Government debt. The process can secure a lower overall interest rate to the entire debt load and provide the convenience of servicing only one loan.
Debt consolidation means combining different debts into a single debt. The process includes issuing a new loan in place of several smaller loans. Consumers use debt consolidation options to ease the financial burdens of loan payment. The consolidated new loan usually entails lower monthly payment either due to extension of payment period, decrease in rates, or both.
Benefits of Debt Consolidation
Debt consolidation provides various benefits to the individuals. Consolidating the debt allows individual to carry on making the loan payments in case of facing financial difficulties. As a result the individual is able to avoid defaulting on the loan that would have negatively impacted on the credit score.
Consolidating the loans is a wise choice when the individual’s credit score has improved since the time the loan was obtained. Due to improved credit score, the borrower will be able to obtain the consolidated loan on a more lenient term than before.
Lastly, consolidating several loans in one loan avoid the chances of missed payments. A single loan is easier to pay as compared to making several payments for different loans. An individual will be better able to track the amount that is due on a loan, thereby ensuring a timely and prompt installment payment.
Pitfalls of Consolidating Debt
There are certain pitfalls related to loan consolidation that individuals should know about. Firstly, a new consolidated loan may extend the loan repayment period. This would reduce the monthly installment amount. However, it would also increase the interest amount as the individual has to make payments for a longer duration.
Another limitation of loan consolidation is that it does not remove a person from his or her responsibility to repay the loan. Individuals should not think of loan consolidation as getting rid of the loans. The method helps in reducing the loan burden by lowering the monthly installment amount only. It does not result in lower net interest or principal loan amount.
Lastly, individuals should beware of loan consolidation companies that consolidate the loans by home equity line of credit. This puts the property of the individual at risk, and the individual would have to part with the property in case of default of the loan. Putting the house at risk to lessen the financial burden through consolidation is not a wise choice.
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