How Do Consolidation Loans Work?

  • Are your debts getting out of hand?
  • Are you battling to pay off all your monthly installments?
  • Have you lost control of your debts?

Maybe it’s time to see a debt counselor or financial service-provider to have your debts consolidated. But what does that mean?

A consolidation loan is when a financial service-provider consolidates/lumps together all your debts into one debt that you have to pay off over a certain period of time, at a particular interest rate. In other words, you have only one instalment to pay every month instead of having to make multiple payments.

What you should be looking for is a lower interest rate and monthly payment than you have had in the past. But before agreeing to a consolidated loan, there are a few things that you should consider …

Do your research

Before agreeing to a consolidation loan, do some shopping around. Your new loan should offer a lower monthly payment, and interest rate than the combined costs of your consolidated repayments did.

If it doesn’t, there’s not much point in consolidating your bills. The idea is to get out of debt and start again with a clean slate. There are lots of financial service-providers out there, so do some Googling to find your best options.

Read the small print

Unsuspecting consumers can end up being hoodwinked by certain clauses in consolidation loan agreements, so it’s essential to read absolutely everything in your agreement, including the fine print.

For example, some lenders insert a clause into their agreements whereby the consumer is compelled to pay a higher monthly payment after a certain time period has elapsed, such as 12 months. Make sure you read everything before making a decision to go with a particular service provider.

Don’t get too excited

As one financial advisor said, it’s still a loan, even if it does offer some financial relief. Be careful of continued over-spending as interest rates might rise, seeing you paying a higher premium towards your loan.

This could put you under serious financial pressure. Cut up your credit cards, and make up your mind not to get into any more debt. That way, you can ensure that you never end up in this position again.

It takes longer to pay off

Consolidation loans, because the loan is spread over a longer period than your original debts, take longer to pay off. In fact, it could take you anything from five to 25 years to get rid of the debt, quite a sobering fact. This is partly because many debt consolidation organisations charge high-interest rates and upfront fees.

The result of this is a larger, more expensive debt than you had originally, often with higher interest rates. While your monthly installments should be lowering than what you were originally paying, the debt certainly takes longer to pay off and is more expensive in the long run.

You’re probably not reducing your debt

Consolidating all your debts into one larger debt doesn’t reduce your debt, so it’s not a permanent solution for cash-strapped consumers. The debt will probably be more, considering upfront fees and higher interests, and will take longer to pay off.

The painful truth is that if you don’t deal with the behaviors that caused you to become over-indebted in the first place, you’re likely to remain that way for the rest of your life.

In Summary:

Advantages

Only one instalment per month.
Instalment should be less than the total you were paying.
You pay off accounts that might affect your credit rating.

Disadvantages

Longer debt.
No reduction in debt.
Temptation to spend more again.

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