When you’re trying to fix your finances, you might have come across the term, debt consolidation. What’s the deal with debt consolidation? How can it be helpful for you?

What Is Debt Consolidation?

Debt consolidation refers to the process of taking out a new large loan to pay off all other debts. The idea is that it is easier to manage one debt instead of multiple ones. More importantly, the new loan usually has a lower interest rate than most if not all of the smaller loans that it pays off.

Debt consolidation is usually used for dealing with student loan debts, credit card debts, and other high-interest debts. This process does not magically do away with your financial obligations. Instead, it makes things easier for you so you can deal with your debts more easily.

How Debt Consolidation Works

Let’s say that you are having a hard time with your student loans and multiple credit card debts. You can meet the payments for them but the interests are giving you a hard time. You can then apply for a debt consolidation loan which would take care of all your financial obligations and get a better term at the same time.

You can apply for a debt consolidation loan to your bank or credit union. You can also use your credit card for this purpose, as long as the terms are favorable. Usually, if you have a good relationship with your bank or credit union, your application is going to be approved.

There are also institutions that specialize in debt consolidation loans. Financial institutions usually approve these applications because there is a good chance of them getting paid back. The fact that you are seeking this type of loan means that you are willing to pay and settle what you owe.

It’s important to note that debt consolidation will not reduce the principal. You still owe the same amount, you just transferred it. Although you might reduce what you have to pay for in the long run by getting lower interest rates.

Types of Debt Consolidation

There are two types of debt consolidation loans that you can opt for. The first one is the secured loan, which as the name suggests is backed by assets of the borrower. In case you are unable to pay, the assets will work as collateral.

Unsecured loans are not backed by assets at all. Unsecured loans tend to have higher interest rates since they offer no security. 

Things to Consider

On paper, consolidating your debt might seem like the right move for you since it makes things simpler and the new loan might have a lower interest rate. But you have to be on the lookout for a few red flags before you sign anything. A lower payment term could mean you end up paying more in the long run. 

Debt consolidation can also have a negative impact on your credit score, at least initially. That’s because long-standing debts with regular payment histories are better for credit scores.

These are just a few of the things that you should know about debt consolidation. If you’re having a hard time making sense out of all your debts, right now, this can be the best financial move for you.