Debt consolidation is defined as combining smaller unsecured loans into a larger one then seeking out a loan to repay them. This is an advantage as the larger loan becomes easier to repay because of better interest rates or lower monthly payments and this may result into the loan being paid off faster. Some of these smaller loans include student loans, liabilities and credit card bills.
In the United States of America for example, there are several ways to consolidate debt. One way is through a fixed rate personal loan. This loan may be secured or unsecured. Being secured means that it is backed by an asset such as car that serves as collateral for the loan. An unsecured loan means that it is not backed by an asset. The latter type of loan has higher interest rates due to the risk classification and is more difficult to obtain. The interest rates on these debt consolidation loans are usually lower than the rates on credit cards. Through obtaining this loan, the borrower can use the loan funds to repay the other debts then pay back the loan over the set term, in installments. Another option is to take a home equity loan. This type of loan is secured by a house, which serves as collateral. It is riskier because if the borrower defaults payment, they may lose their home.
Another option is using a 401(k) loan. This is where the person in debt borrows money against their retirement savings to pay off debts. It is a good option because of its relatively low interest rates and the interest is paid to the borrowers account. However experts advise that this should only be considered as the last option as this type of loan disrupts the retirement savings and it may come with repercussions from the tax authorities. There might be no impact to the credit score of the borrower but the loan does not sort out the reasons as to why the debt was accumulated in the first place. 401(k) plans usually allow users to borrow up to half of their savings for a five year period.
The other option is to obtain a balance transfer credit card. If the applicant has good credit, they may be eligible for an introductory period with no interest which can range between six to twenty four months.
Debt consolidation is usually the best idea when the total debt is not greater than half of the total income. The income should be able to cover the payments towards the debt. Also, financial experts advise that the borrower should meet a debt consultant and devise a plan to avoid getting into debt again.
However, if the debt is small and can be paid off within six to twelve months, debt consolidation should not be an option. If the total debt is over 50% of the total income, it is wiser to seek debt relief.
Debt relief otherwise or sometimes referred to as debt cancellation is the partial or total forgiveness of debt owed by individual, corporations of organization by the creditor or lenders