The overwhelming weight of debt that has grown to uncontrollable proportions causes stress that most people are unable to handle. A solution must be found, but high levels of debt with minimum payments that are unreasonable for households with tight budgets are difficult to pay down. Many people choose to ignore their debt problems because they do not think that there is any way to pay off their balances, but accounts that continue to go unpaid will go into collections. One way to get debt under control is by consolidating it.
What Is Debt Consolidation?
Debt consolidation simply means that a person takes out one large loan to pay off all of their debts. Borrowers use the proceeds of the loan to pay outstanding debt balances, and the result of this process is that borrowers will make only one payment on one loan each month instead of making several payments on various sources of debt.
Methods of Debt Consolidation
There are several ways to achieve debt consolidation. The best method depends on the total balance of outstanding debts, the credit rating of the borrower and access to these sources of consolidation loans.
- Home equity loans allow borrowers to tap into the financial resources found in their home. The amount that can be borrowed is often high, and interest rates on home equity loans tend to be low.
- Credit cards may offer promotional rates on balance transfers. People who have several credit cards may want to use promotional interest rates to consolidate their debt for savings.
- Personal loans can be used for debt consolidation, but banks generally require borrowers to have a very high credit score to obtain a large personal loan.
- Debt consolidation loans are loans that have lower interest than most credit cards. Companies that offer these loans promote the reduced monthly payment that borrowers enjoy when they consolidate their debt by using this financial tool.
The Process of Debt Consolidation
Borrowers start the debt consolidation process by choosing the consolidation method that works best for their needs. The right choice depends on interest rates that are available and the maximum amount of each type of loan. People will need to take their total debt balance into consideration when choosing the right method for their needs.
It is important for people who are dealing with debt to sit down and do the math to ensure that consolidation will save them money. The primary purpose of consolidating debts is to reduce the cost of paying off debts.
Borrowers should only apply for loans after ensuring that they qualify. Each loan application is likely to result in an inquiry on a credit report, and people who have a high number of inquiries in a short period of time will experience a decrease in their credit score.
If the lender approves the loan application, the proceeds of the loan are typically paid to the borrower. The borrower is then responsible for using these funds to pay off their debts. However, some lenders may directly pay off debt balances instead of sending money to the borrower.
Debt consolidation loans have a set monthly payment. The duration of the loan will be outlined in the agreement that a borrower must sign before funds are dispersed.
Benefits of Debt Consolidation
There are many benefits of debt consolidation.
- Borrowers can save money on interest.
- Total monthly debt payments are reduced by a combination of lower interest and longer repayment terms.
- Budgeting for one debt payment each month is more convenient than keeping track of payment amounts, due dates and lenders for several debt sources.
Debt Consolidation and Credit Rating
One negative related to debt consolidation is that the process can decrease a borrower’s credit score. The reason for this decrease is the fact that banks run credit checks during the application process. The inquiries that result will stay on a credit report for two years, and inquiries have a small impact on credit score. Having too many inquiries can bring a score down up to five points.
However, debt consolidation often does not bring down the borrower’s credit rating. The process can actually improve credit score by allowing a person to pay off debts instead of missing payments each month.
Biggest Debt Consolidation Companies
There are many companies that specialize in debt consolidation. These lenders are more likely to approve financing for consolidation purposes. The debt consolidation companies listed below are the biggest in the industry.
- LendingTree offers quotes from banks for financing including mortgages, vehicle loans and debt consolidation loans. Online quotes from multiple banks allow borrowers to find the best loan terms from the convenience of home.
- Lending Club offers fixed-rate debt consolidation loans. The entire application process can be completed online.
- Prosper allows people to borrow between $2,000 and $35,000 for debt consolidation. The amount that a person can borrow depends on factors including credit score and income