What Is a Debt Consolidation Loan?

What Is a Debt Consolidation Loan?

A debt consolidation loan is a type of financing for people that have multiple debts. It allows them to consolidate (or combine) all of their debts into one new loan.

debt consolidation

Although debt consolidation loans can be used to reduce the number of billing calls you receive from multiple lenders.

What else can you do?

  • You make one monthly payment to one place instead of many
  • Opportunity to improve your credit score over time by making timely payments

Secured Debt Consolidation Loans Vs. Unsecured

The two main types of consolidation loans are secured and unsecured. Secured loans are linked to an asset (home, car, real estate) that serves as collateral against default on your loan. Unsecured loans are not related to assets and are based largely on your credit history because it is considered high risk for a lender.

Secured loan: positive and negative

  • Easier to get from a lender
  • Higher loan amount granted
  • Lowest interest rate
  • Possible tax deductible interest rate
  • Longer repayment terms (higher interest cost over time)
  • Risk of loss of assets

Unsecured loan: positive and negative

  • No risk of assets
  • Shorter depreciation term (lower interest cost over time)
  • More difficult to obtain from a lender (high risk borrower)
  • Less amount borrowed
  • Higher interest rate
  • No tax advantage

The simplest type of consolidation loan could be a credit card balance transfer with 0% interest. If your credit is strong enough, a card company can allow you to consolidate the debt of several cards and put them all on one card at no charge per transfer and no interest for a limited period, usually 12 to 18 months.

Another option is a consolidation loan from a credit union or a linked online lender. Qualification requirements are generally less stringent than banks. Your application is quickly evaluated and interest rates are generally more favorable than what you currently pay.

How Does A Debt Consolidation Loan Affect My Credit?

A debt consolidation loan can give you the opportunity to improve your credit if you use it as a financial plan instead of just changing the debt. When you buy your consolidated loan, your credit card debt will be fully paid and you will focus on paying off your single new loan.

If you need a consolidation loan, you can assume that your credit has already been affected by late payments. As your score will not improve immediately, timely repayments of the new loan will begin to have a positive impact on your credit rating over time.

If you do not have a good credit rating, talk to a credit counselor at a nonprofit credit counseling agency to examine other options. They can recommend a debt management program that will help you set a budget and pay off debt within 3 to 5 years.

Keep in mind that not all financial problems can be solved by a debt consolidation program. There are certain situations where debt settlement or even bankruptcy is the best solution to the problem.

Useful Tips to Remember When Signing a Debt Consolidation Loan Agreement

  • Do your research. Different banks offer competitive loan rates and variable repayment terms. Keep your options open because credit unions can also compete with the bank’s competitive rates.
  • Stay on budget. Before repaying the monthly payments on your consolidation loan, look at your income in relation to your expenses to determine a realistic monthly payment.
  • Make the loan a priority. Do not ask your eligibility for new credit card deals or accumulate additional debts on your existing cards because both will have a negative effect on your credit score.