Student loans, car loans, credit cards and mortgages are some common forms of consumer debt. Debt is a part of our economy, but poor debt management can lead to financial instability.
A debt consolidation loan is a method of managing consumer debt by taking out a larger loan to pay off multiple smaller debts. It can be beneficial for people who are struggling to manage multiple high-interest loans. With debt consolidation, you can combine smaller liabilities into a single loan with more favourable terms, like a lower interest rate. You can consolidate credit card debt, student loans, CRA debt and personal lines of credit, but you can not consolidate debt like mortgages and car loans, which are backed by an asset.
How to Consolidate your debt?
There are different ways in which debt can be consolidated and the best method for you would depend on the type of debt and the terms of repayment. Debt can be consolidated using secured loans or unsecured loans.
A secured loan is backed by an asset used as collateral. Interest rates are lower and qualifying amounts are higher with secured loans. With a secured loan, the lender has a legal claim on the collateral if the lender defaults. Secured loans include home equity loans and home equity lines of credit (HELOC) taken out against your home equity.
An unsecured loan is not backed by any assets. It usually has a higher interest rate, lower qualifying amount and requires a higher credit score. However, the approval timeline is shorter for unsecured loans. Unsecured loans include credit cards or personal loans from a bank or credit union.
Requirements for debt consolidation
When applying for a debt consolidation loan, the lender will consider the following requirements before approving you:
- Income- You will need to show that you have enough income to support your monthly expenses and an additional loan.
- Credit History- A good credit score and a history of payments made on time.
- Equity: For a home equity line of credit or a home equity loan, the lender will assess how much equity your home has.
Like any loan, the lender will want to know that you are a good financial risk and will be able to repay your loan on time.
Benefits and Risks of a Debt Consolidation Loan
A debt consolidation loan could help you streamline your finances and simplify your payments with a single payment and interest rate. It could also increase your credit score as you pay off your larger debts. There are many benefits to a debt consolidation loan, but it does come with some risks. There could be closing costs, annual fees and credit card transfer fees depending on the type of loan. You could also end up with a longer repayment term on the new loan. There is also the risk of losing assets used as collateral for secured loans.
Should you consolidate your debt? It could help you manage your finances, but it is not the best solution for everyone. Debt consolidation will reduce your number of payments, but it will not fix bad spending habits or a high debt-to-income ratio. We are here to help you figure out the best way to consolidate your debt. Contact us today to get started.