Overspending or using your credit card regularly to make payments can easily lead to debt accumulation. Paying it off can be difficult and can leave you overwhelmed if you have several loans. This is where debt consolidation loan comes into play.
It allows you to combine these debts and repay them as one. However, it’s not an easy option as it works well for people who have low credit scores. We explain the advantages and disadvantages of debt consolidation loans.
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Pros
Usually, you wouldn’t take another loan to repay your existing loans but here’s why you should consider this particular type of loan.
Organize Your Finances
A debt consolidation loan enables you to keep track of all your existing debt and reduces the amount of payments and interest incurred. As a result, it reduces your chances of missing or making late payments.
Fast Track Payments
Paying your outstanding loans together shrinks the time needed to repay each loan. Having a lower interest also means that you’ll save money and you can redirect those to paying your debt.
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Lower Interest Rates
The interest rate you get depends on your credit card score and the length and amount of the loan. If you’ve got a healthy credit card score, you have a chance of getting low interest rates than what you’re currently paying.
Improve Your Credit Score
At first, a debt consolidation loan will cause a dip in your score, but in the long run, it’ll improve. Since you’re working on a single repayment schedule, you have a high chance of making timely payments. This significantly improves your credit score.
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Cons
If you’re considering applying for a debt consolidation loan, you should be aware of its drawbacks. Here are some.
It’s Not a Quick Fix to Your Financial Problems
Because all your loans are now under one repayment system, it doesn’t mean your financial issues are solved. Refrain from adding more debt. It’s probably the best time to work on your financial discipline and work to avoid unnecessary debt.
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Deal With Additional Costs
Debt consolidation loan comes with extra costs. Before signing up, know the fees you’ll incur and how that impacts your finances. Some of the extra fees include:
- Balance transfer fees.
- Closing costs.
- Annual fees.
- Loan originating fees.
Damage Your Credit Score
Loan consolidation helps in organizing your finances, but if you can’t afford you risk having a poor credit score. Missing any monthly payment attracts additional charges and decreases trust in lenders. If you’re reported to the credit bureaus, you might find it hard to qualify for future loans.
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Risk of More Spending
Loan facilities might give you a false impression of having more money and thus increase your spreading rate. Ensure you honor your debt obligations without digging yourself further into debt.
Higher Interest Rates
If you don’t have a good credit score, there’s a likelihood of a higher interest rate as creditors consider you a high risk. Review your existing loan terms.
When Should You Apply for a Debt Consolidation Loan?
You need to understand your circumstances before applying for any loan. Debt consolidation loan works well under these considerations:
- Huge debt. This will enable you to streamline your finances and get terms that make it easier to honor your monthly payments. If you have a small debt, repay it without adding another loan.
- Improve your financial habits. If you get into debt because of poor financial habits and are serious about fixing it, then a debt consolidation loan will go a long way. Identify the loopholes and make plans to deal with them so that once you’ve finished paying off your debt, you’ll not restart the cycle.
- Healthy credit score. If you have a good credit score, you’ll qualify for lower interest rates which is a money saver.
- You can afford it. If you’re struggling to repay your existing loans, adding a debt consolidation loan might not be a good decision. Only apply for it if you can keep up with the payments.
A debt consolidation loan is an attractive option, but remember that it’ll only be helpful if you have a good reason for taking it. Understand your financial position and evaluate whether adding this new loan to your existing debt makes sense. It’s not a quick fix to your problems and it will only work if you’re financially savvy.
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