Debt Consolidation – Advantages and Disadvantages

Debt consolidation is an effective way to eliminate piled-up debts. It can be used as a stepping stone to minimize and finally, clear away debts.

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So, how does debt consolidation work?

Say you have multiple loans/debts waiting to be cleared. Now, if you take a single loan and clear away your debts using this loan, you have just consolidated your debts. In other words, debt consolidation essentially refers to a loan, specifically taken to clear away pending debts and liabilities; and in the process creating a single loan with a single monthly payment.

What are the pros of debt consolidation?

1. Handy mechanism to clear debts – The consolidation loan you take up is virtually large enough to accommodate all your debts. The one payment you make towards this single loan is used to pay off other debts. Since this happens regularly over a period of time, you clear your debts in a systematic manner, without having to worry about making multiple payments. If you transfer your credit card debts on to a single credit card (credit card balance transfer), you are usually offered very low interest rates (sometimes zero percent) on your new card.

2. Reduce the interest you pay – As is often the case, it is not only the debts owed but also the interest charged on the debts that cuts a hole in your pocket. Credit card balances, in particular, are charged at a high rate of interest. By choosing a debt consolidation loan at a rate lower than the one at which your previous debts were charged, you not only pay off your outstanding loans and debts, but also pay lesser for the consolidation loan you have taken.

3. Make your payments easy-to-manage – As the debt consolidation loan is used to pay off other debts, you just have to make a single payment (for the consolidation loan you have taken). It is easier to plan and manage a single payment as compared to a number of payments. Thus, you save yourself from making multiple payments.

4. Budget-friendly tool: low monthly payments – When you opt for a debt consolidation loan, it is generally extended over a lengthier time-period. Since you pay for a longer duration, the amount you pay per month is effectively lowered. This helps in easing out your monthly budget.

What are the cons of debt consolidation?

Sometimes debt consolidation may throw up a couple of disadvantages. Here is a glance at some of them:

1. Risks involved – A debt consolidation loan, when taken against a home or any other property, may pose a threat in case of any failings to keep up with the payment schedule. In case of defaulting with payments, you stand every chance of losing your property.

2. May turn out be expensive – When the time-period for the loan is long, you pay for an extended period of time. Also, at times there are hidden costs associated with the loans and (relatively) high interest rates which might translate into you paying more than what seemed you planned at the outset.

3. May hurt your credit scores – With debt consolidation, you have just one payment to make per month. You make this payment to a single creditor. If for some reasons, your payments are not on schedule then your credit scores might suffer due to bad payment history. Since you only owe to a single creditor, the chances of improving on your payment history by making other payments on-time do not exist. There are times when a number of credit checks are done on your credit report by your creditor. This has an adverse effect on your credit scores.

4. Scams and counterfeits – There are a number of scams and fake debt consolidation organizations that are doing the rounds. In case you fall for one of them, it will jeopardize your financial situation for a long time to come.

So, will consolidating help me get out of debts?

The answer is different for every individual depending on his or her financial circumstances. However, if used with a sense of purpose, planning, and effective implementation, debt consolidation can be put to good effect. The onus lies on an individual to make the best use of it. Consulting a debt consolidation professional or debt counseling service is also a good option.