Personal finances become complicated with multiple loans running at the same time. You pay different interest rates and with different methods for personal loans, credit card dues, education loans, or car EMIs. Due to this diversion, most of the time, one misses payments, which then leads to interest piling up and ultimately financial stress. Debt consolidation is becoming the trending answer these days, which combines multiple loans into a single payment every month.
First start with understanding what exactly is debt consolidation.
What is Debt Consolidation?
Debt Consolidation refers to the combining of two or more existing loans or debts into one new loan. Instead of making multiple payments to several different lenders every month, you just make one payment towards the consolidated loan.
Most commonly, people consolidate unsecured debts, including credit card debts, personal loans, and medical bills. The reasoning behind the consolidation of loans could be to simplify repayments, to receive a lower rate of interest, or to extend the period of repayment so that the monthly payments become less cumbersome. A bank, an NBFC, or a fintech lender may offer the new consolidated loan.
Why Do People Choose to Consolidate Their Loans?
There are several reasons why debt consolidation can be an attractive option. Refer to the below pointers:
1. Simplified Finances
When you are supposed to pay EMIs for multiple loans, confusion is bound to set in. Even a single missed payment can affect your credit score and also result in late payment fees. When consolidation loans come into the picture, it is just one EMI to remember every month.
2. Lower Interest Rate
One of the prime reasons is to lessen the overall interest burden. If your existing loans carry high interest rates, say, credit card balances, then a consolidation loan at a lower rate will eventually save you money.
3. Improved Credit Score Over Time
If you have had trouble staying on top of multiple payments, consolidating and staying consistent with one payment may slowly help rebuild your credit score.
4. Reduced Monthly Outflow
If you had been finding it difficult to keep up with multiple payments, consolidating them and then adhering to the single payment may eventually help to slowly build a positive credit score.
Types of Debt That Can Be Consolidated
There are multiple kinds of debt that you can consolidate:
- Credit card balances
- Personal loans
- Medical bills
- Payday loans
- Overdraft balances
- Unsecured business loans
Usually, secured loans, such as home loans or vehicle loans, are not consolidated through this process since those are given with collateral and have comparatively low interest rates. Although, probably, in some instances, they could be considered as part of refinancings.
But, How Does Debt Consolidation Work?
Here’s a step-by-step look at how the process typically works:
- Assess Your Existing Debts: Begin by listing all your current loans, including the outstanding balances, interest rates, and EMI amounts. This helps you understand the total burden and how consolidation could benefit you.
- Check Eligibility for a Consolidation Loan: Financial institutions assess your credit score, income, and debt-to-income ratio to decide whether you qualify. The better your credit score, the more likely you are to get a favourable rate.
- Apply for the Loan: Once approved, the lender will either pay off your existing loans directly or deposit the funds into your account for you to close your debts.
- Repay Through a Single EMI: From this point onward, you will be making one EMI payment each month for the new consolidated loan.
Important Things to Keep in Mind
While it may sound straightforward, debt consolidation is not suitable for everyone. Here are a few considerations:
1. Total Cost of the Loan
A longer repayment period can reduce your monthly EMI but may increase the total interest paid over time. Always check the total repayment amount before proceeding.
2. Processing Fees and Charges
Some lenders charge a processing fee, prepayment penalties, or foreclosure charges. Be sure to read the fine print and factor in these costs.
3. Behavioural Traps
Debt consolidation can give temporary relief, but if you continue to use credit cards or take new loans without changing your spending habits, you could fall into a deeper debt cycle.
4. Credit Score Requirements
Not everyone qualifies for low-interest consolidation loans. If your credit score is low, the interest offered may not make consolidation worthwhile.
Who Should Consider It?
You might benefit from a consolidation loan if:
- You are currently paying high-interest debt, such as credit cards or payday loans.
- You are missing payments due to scattered due dates.
- You have a stable income and can commit to one EMI consistently.
- You want to simplify your financial life and improve your credit health over time.
Final Thoughts
A pile of loans can very soon become overwhelming, not to mention high-interest rates and different due dates. Debt consolidation is a practical way to alleviate some stress from your life, reduce your monthly obligations, and organise your financial commitments within a specific timeframe.
However, it is not a cure-all. It will only work if consolidation goes hand in hand with cutting expenses and staying disciplined with repayment. So, choose wisely!
