How Does Debt Consolidation Work?

Many people might not know about debt consolidation. It is perfectly fine to educate yourself, and this piece can help you with that. Debt consolidation is the process of summing your loans together and paying them as a single loan. Over the years, you may have taken up several loans in your name, and repaying them might be difficult. Gathering several loans with high-interest rates can put a lot of burden on you. Putting all of them together can help decrease the load and make it easier for you to pay them off. 

Debt consolidation does not mean that you get to skip on the debt, but it only makes it easier for you to manage your finances. 


What is the Difference between Debt Consolidation and Debt Settlement?

Among several people, you might have also confused yourself between debt consolidation and debt settlement. It is a very common mistake as both the terms are often used interchangeably. There are, however differences that set the two apart. The concept of debt settlement comes in when the lender has to take help from a third party to retrieve loans. The third-party company comes up with a negotiation that both the parties agree on and then decide the balance payment.

On the other hand, debt consolidation does not involve any other party but gives you the space to put all your outstanding balances together and pay them off using a new loan. Once you take out a new loan, you solely have to pay that loan back. What’s more, borrowers can come up with a plan of their own where they decide the payment schedule that suits them the best. 

Debt consolidation: Combining all your debts together with a new loan.
Debt settlement: When a lender uses a third party to help them collect debts.

Steps Included In Debt Consolidation

To get a loan consolidation, you need to follow certain steps. Here are some that might help you consolidate the loans quickly. 

  • Review your Credit Score 

  • Your credit score is very important if you plan to acquire debt consolidation. Your credit score must be high, because if it’s not, you must consider improving it. Needless to say, poor credit scores lead to rejections.

  • Search for a Loan 

  • Debt consolidation loans can also be personal loans that you take in order to pay off other loans. The first bank you must reach out is the bank you currently use. They might be able to come up with a better solution as they have your complete credit history. Look through all the options they give, after which you can move on to other backs and services. 

    It is always a wise idea to review several services before you decide on one. This will help you look at all the different options, and it will also help you make a well informed decision. It is also important to make yourself familiar with the debt consolidation regulatory framework.

  • Choose the Right Loan 

  • There are several things you must consider before you take your pick. For instance, you must make sure that the bank you choose offers you the right loan amount. It would also be ideal to consider if you will be able to pay off the monthly installments they offer you. 

    Gather all the information you can about your loans and make sure you understand every single aspect. Not understanding anything might result in much bigger problems later on. 

  • Get an Approval 

  • Attach all the necessary documents and then apply for the loan. Once the loan is approved, your loaner will receive money from your creditors. 

Having a good credit score is very important before applying for debt consolidation.

How Debt Consolidation Works

Let’s get to the nitty and gritty of how debt consolidation works. The borrower typically applies for a personal loan, or they might also apply for a balance transfer. Either way, they will consolidate their debts. If you take a debt consolidation loan, the lender in this case might pay off your loans directly. If not directly then the loaner can take cash and pay all the loans on their own. Similarly, if you take up a balance transfer, you can choose from different ways to consolidate your balance. 

As soon as the outstanding balance is paid off, you will have to start paying monthly installments for the new loan. Since it is a way to make it easier for people to pay off loans, you typically have to pay off a smaller sum of money in installments compared to before. This does not mean that you have to pay a smaller amount altogether. Companies do decrease the number of monthly payments but they also increase the number of months you need to make the payment for. 

By consolidating your loans you make it a lot easier to pay off your debts. It also helps you save a considerable amount of money. For instance, if you have three loans and each of these loans have an APR of 10-15%. That means that you don’t just have to pay the outstanding balance but the interest on that outstanding balance too. 

The interest keeps on increasing and adding to your outstanding balance. In this case, it is a great idea to consolidate your loans. This way, you won’t have to pay interest on each loan but on a single loan which typically has a smaller amount of interest

Loaners with a high credit score can also opt for a balance transfer card that has a 0% APR. This way, you won’t have to pay interest on your amount at least for a year. 

Consolidating your loan will help you only pay interest on one loan instead of a few loans.

Now that you know how debt consolidation works, do you think that it is the best fit for you? Consolidating your debts is, without doubt, a great idea for people who have a stable income and know that they will be able to pull off the monthly payments. Moreover, you must also dedicate yourself to avoiding taking any more loans and piling them up. 


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