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Debt Consolidation: What is it? How Does it Work?

A debt consolidation loan is usually unsecured. They are used solely to clear all your current outstanding debts. Consequently, all your previous debts that are compiled into one big loan. A debt consolidation loan contain relatively lower interest rates, and smaller monthly payments. This could be a great tool to pay off student loans or credit card debt.

Options for Debt Consolidation

There are five types of debt consolidation loans which can help you resolve all the debt related problems. They are a mix of secured and unsecured loans. For a secure debt consolidation loan, you will have to place an asset as collateral. A debt consolidation loan is typically unsecured and doesn’t require any collateral but has high eligibility requirements.

  1. Consolidation Company
    A debt consolidation firm will take up the responsibility to clear all of your debt. They will approve you for an unsecured loan, where the lender agrees to pay all your debts. They will take up the responsibility to personally clear the debt. You wouldn’t even be provided with any money. In addition, to paying off your debt, some firms also provide you financial advice. This is recommended to reduce the amount of payment and charge a lower interest rate.
  2. Personal Loan
    These are normally unsecured loans which can be used to consolidate your debt. Unlike the debt consolidation loans, the lender is not concerned about how you use the loan. It can be sued to pay off some of the debt or none at all. To rebuild your credit score and establish discipline, you should clear the debt. How does a personal loan work with poor credit?
  3. Home Equity Loan
    Since you will be placing your house as collateral, this is a secured loan. This option is not recommended unless the situation is dire. Putting your house on the line can be dangerous, in case you fail to make the payments. The home equity loan can be used to consolidate the loan.
  4. Balance Transfer
    In this option, you open a new credit card account. This will be used to clear the debt on multiple cards. The debt from your current credit accounts are transferred into this new one. It is similar to the debt consolidation loan, where you take one big loan to pay off all the others. Since, the credit accounts can be used to make payments interest free for the first few months, make the most out of that time.
  5. Government Loan
    Additionally, there are loans offered by the government to clear the debt. A federal student loan consolidation can be used to clear all the student loans debt. It is easier to apply for a federal consolidation debt loan. They charge the average of all the other student loans. You should know, loans marked under collections are not included. Ideally, a federal loan can be used to make the payments more swiftly.

What Are The Advantages?

No More Debt

It is possible that you haven’t been able to pay off all the debt or missed out on a few due dates. Eventually, these piling debts would become problematic. The stress of dealing with the due dates, interest rates and the payment schedule for multiple loans can be stressful. One loan to wrap them all up in a tiny bow would save you from all the hassle. The collection agencies will stop chasing you as well. You will only have to deal with one due date, one payment and one interest rate.

Tax Benefits

In addition to all the debt consolidation, the borrower could also enjoy some tax benefits. This is only applicable for a secured loan. The internal revenue system (IRS) might find you eligible for a tax deduction. This factor can only be possible if you have taken a home equity loan. A tax deduction saves the borrower from an increased tax liability.

Burden of Debt

The biggest win for a borrower is the main purpose for a debt consolidation loan. They are no longer liable or chained to surmounting debt. With one swift move, they can dodge the urgent need to pay off loans. A debt consolidation loan can be a great assist.


Term of Loan

The term period of a loan can be a vital factor. On paper, the interest rate and payments might seem lower, but it has a longer term. The lender could be charging more. It is widely common for a lender to extend the term of a loan in order to maximize the returns. Compare the payment of your current debt with the payment of the debt consolidation loan. It could provide you with a better understanding about how to deal with the unsecured loan.

Secured Loans

On the other hand, if you fail to make payments for a home equity loan, your home is in danger. Defaulting on a debt consolidation student loan will result in tax refund.

Debt Consolidation

A debt consolidation loan is typically accompanied with higher interest rates and larger payments. Taking a personal loan can be more feasible to get rid of debt. You can easily pay off the debt at a lower interest rate.

Related: $500 Loans for Bad Credit

Credit Score

Managing to pay the loan earlier will improve the coverall credit score. It could also improve the utilization ratio, which is a positive factor. However, there are a few negative impacts on your credit score as well. Initially, the debt consolidation loan will reduce your credit score. Since, the borrower has just opted for a new debt that is significantly large, it would increase your risk.

You need to be more financially responsible with the spending and debt management. Replacing your debt with one large one doesn’t forgo your responsibility to meet payments on the due date. You need to use this opportunity to rebuild the credit score and grasp a control of your finances.

Tips for Poor Credit Debt Consolidation

In case your credit score is significantly low, you might face difficulty in receiving approval for a debt consolidation loan. There are four methods that can be sued by a borrower with poor credit score.

  • Credit Unions
    Being a part of the credit union can be of great help. They will always aid their members and provide you with guidance or help in the application of debt consolidation.
  • Online Lenders
    Online Lenders readily available can provide you with the loans. It is imperative to make sure that the lender is reliable and trust worthy.
  • Family or Friend
    A close friend or family with sufficient finances might be able to help you get out of this tedious situation.
  • Retirement Plan
    A controversial option, is using the retirement fund beforehand. The taxes will be applied more than once. Failure to recoup that payment could harm you at retirement.

Ultimately, the debt consolidation loans will guide you out of the trouble. Keeping it that way is your responsibility. Proper management of your finances is vital in the long run. Remember to keep making the payments on time. Don’t let your debts pile up in the future. Most importantly, try to improve the credit score.

Next: How to Get a Payday Loan with Bad Credit


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