What Is Debt Consolidation, and Should You Consolidate?
Debt consolidation means to take a new debt/loan at a lower interest rate to pay off all your existing debts/loans. Debt consolidation helps you to reduce your debt, pay off your debts faster to come out from debt trap.
When you consolidate your debt/loans, you are combining multiple debt/loans into a single debt/loans.
Debts consolidation also allow you to opt favorable paying terms, lower interest rate and lower EMI.
If you have taken multiple debts/loan like personal loan , credit card loan, two-wheeler loan, car loan etc with different interest rates and different due dates and you are struggling in managing them, then debt consolidation is the best approach for you.
In debt consolidation, you take enough debt/loans to pay all off your current debts/loans including loans from local money lenders and taken one higher amount of debt/loans from single lenders.
Advantages of debt/loan consolidations :
If you do debt/loan consolidation then you have only one single loan EMI that is easy to manage.
If someone pays car loan EMI Rs. 10625, personal loan EMI Rs. 12697, T/W loan EMI Rs. 1858 and credit card EMI Rs.3924 on different due dates. He pays a total of EMI Rs. 29104/-
If he do debt/loan consolidation and his new loan EMI is Rs.21843/- then it is more beneficial and pays only single EMI.
(Please read an article for calculation details of EMI )
Lower Interest Rate :
When you do debt consolidation then you negotiate with the bank for a lower interest rate which will reduce your EMI burdens.
Nowadays banks offer a balance transfer scheme where they offer a higher loan to pay all other financier loans at a lower interest rate and lower processing fees.
Stop you in taking fresh high-interest loan :
When you do debt consolidation then you pay all of your existing loan with a new loan, after this, you need not take any higher interest loan to pay off your credit card bill or for other expense.
Increase in saving :
When you do debt consolidation then your new loan EMI will be lower than your current loan EMI that means you have the extra amount per month in your bank account which can be used for investment in different financial instruments.
Get out of a from debt trap :
Debt consolidation helps you to get out of from debt trap because you pay your all existing loan of higher interest rate and take fresh loan at a lower interest rate which reduces your monthly EMI. This saving in monthly EMI will help you to get out from a debt trap.
When should you consider a debt /loans consolidation?
You should go for debt consolidation only when :
When Lenders offer you a higher loan at a lower interest rate
Debt consolidation or loan consolidation work only if you are able to get new loans from financial institution /banks at a lower interest rate and loan amount to wipe off all your existing loans.
To getting new loans at a lower interest rate you should check the rate of interest of all the lenders and terms and conditions of loans then you go for one.
Many financial intuition and banks offer balance transfer scheme where they offer lower interest rate , low processing fees and higher loan amount to pay off your existing loans. This is one of the approaches you can check if it is feasible for you.
Mr. Ram is in debt trap and he straggling to pay his existing loan monthly EMI, he has taken different loans from lenders at a higher interest rate and now he is planning for debt consolidations.
Following are loans of Ram’s
|Type of loan||Loan amount||Loan interest Rate %||EMI amount||Principal outstanding as on date|
|Credit card loan||100000||24||3924||74205|
Now we are checking here that whether debt/loans consolidation work for Ram or not.Ram has approached in one bank and applied for an unsecured loan under balance transfer scheme.
Banks has approved a loan of Rs. 9.60 Lac to ram for tenure of 60 month @ 13 % P.a. interest rate subject to the closing of all existing loans. Now after the consolidation of all debts /loans, new loan EMI will be Rs. 21843 which save Rs. 7261/- in monthly EMI payments.
Another approach is to take a mortgage loan for longer time period to reduce current monthly EMI burdens.
As in above example, Ram has applied in banks for a loan against property and bank approved loan against property to him Rs.9.60 Lac for a tenure of 180 months @ 11.50% P.a. subject to the closer of all existing loans.
Now new loan EMI will be Rs. 9200/- which save in monthly EMI Rs. 19904, but here point to be noted that you have taken liabilities for a longer a period of time.
When Ram’s income will increase in future then he can partial payment of his loan and pay off loans before 15 yrs of a time period. This approach will help Ram’s to reduce the higher EMI burdens.
When existing loan Pre-payment charges and new loan processing fees low
Before debt consolidation, one should keep in mind that what are the prepayment charges of existing lender and what will be the processing fees of new lenders, if these charges wipe off new loan interest saving then debt consolidation will not be fruitful.
When future earning allow till the loan maturity :
Debt consolidation makes sense when your future earning afford to pay loan EMI till the maturity of loans. If someone is going to retire in the next 2-3 years then debt consolidation for longer tenure will not work here.
When you ready to take this opportunity to back on track :
Debt consolidation work only if you are ready to take this is an opportunity and ready to reduce your expenses to come back on track again.
You should have to create willing that you will come back with the debt trap. You should try to stop the overuse of the credit card and make a habit to pay the credit card bill on time. Avoid the minimum amount of payment of credit card.
When you should not consider a debt /loans consolidation?
When you can’t afford a new loan :
Debt consolidation will not work if you can’t afford new loan EMI and if your future earning will be uncertain.
When new loans are not sufficient to pay off all existing loan.
Debt consolidation will not work when a new loan is not sufficient to pay off all your existing loans.
In the above example if bank offers new loan Rs.6 Lac to Ram then debt consolidation will not work because the ram is not able to pay all his existing loans and new loan EMI will create an extra burden to him and instead of back from the debt trap, he will be in more debt trap.
When existing loan Prepayment charges and new loan processing fees are higher.
If the existing loan prepayment charges and new loan processing fees are higher then the saving in interest on new loan then there is no meaning of debt consolidation.
Points to be kept in mind when you go for debt consolidation.
Compare All lenders Rate :
Before taking decision you should do a comparison of different banks interest loan and choose the best one which offer you a lower interest rate. Compare processing fees and other charges
Don’t look only interest rate, also check processing fees and other charges before taking debt consolidation decision some lenders offer you a lower interest rate but charge higher charges in form of processing fees and file charges.
When you are ready to save :
Debt consolidation will work only when you are ready to get out of debt trap and act accordingly like saving your expenses. Stop taking any fresh loan.
When you are ready to stop taking any more fresh debts then debts consolidation will help you to get out of from the debt trap otherwise if you are taking new loans then you will be in more debt trap and debt consolidation will not help you.
When you are ready to prepare a budget and ready to reduce your expenses.
Debt consolidation work when you are ready to reduce unnecessary expenses whether it is small or big until you come back on tracks.
When you are ready to increase the extra source of income
Debt consolidation will succeed when you are ready to increase of your extra income through another source of income like tuition , online job work from home, etc. This will helps you to get out faster from the debt trap.
Seek professional helps to get out of the debt trap.
You can take help of professionals who will guide you whether debt consolidation will good for you or not and what will be the different repayment option and what will be the best for you.
Some agencies may also negotiate with banks on your behalf and assist in lowering interest rate and restructure of your loans.
Debt consolidation will help to people who are in debt trap and having many loans at a higher interest rate and straggling to pay monthly EMI.
It will work only when you are eligible to get fresh higher amount loan up to pay all your existing loans at a lower interest rate.
Before debt consolidation, you should keep in mind that you will afford new loan EMI and your future earning will support new loans.
Disclaimer: Above article for Education purpose only, please consult your financial advisor before making any decisions.
Thanks for reading ….