While debts are necessary to build a credit history, unmanageable ones can destroy your credit score. To avoid that, you need to explore debt repayment approaches such as debt consolidation. But before you consider it, know the pros and cons of debt consolidation.
The Advantages of Debt Consolidation
Debt consolidation is a process of “bundling” or combining all your loans to one huge debt. For example, if you have a few years left on your mortgage and credit card debt, you can apply for a loan that covers the remaining repayments and pay off only one loan from now on.
Debt consolidation, therefore, is an approach allows you to:
1. Manage your repayments more effectively – One of the primary reasons why you’re paying more on your loan is delayed repayments. They carry penalties, fees, and charges on top of the interest rate and principal amount. By having only one debt to think about, you’re less likely to miss your payment.
2. Maximize a more affordable interest rate – Interest rates can cause total debt to skyrocket. This is true with credit cards, especially if you’re used to paying only the minimum amount. By consolidating your debt, you can get rid of loans that bear the high interest rate and take up another with a lower rate. Another option is to transfer the balance of your loan to one with a more affordable interest rate. This strategy is popular among credit card users.
If you have a good credit score, which is usually 700 and above, finding more affordable interest rates is easy. If you’re still building your score, you can look for secured loans. The collateral can reduce the feeling of risks among the lenders, hopefully enough for them to give you cheaper interest.
3. Extend the life of the loan – In general, the longer you pay off the loan, the higher the interest you pay. But it makes the repayments more affordable, making it a great option for those who are on a tight budget.
Disadvantages of Debt Consolidation
There’s no perfect debt repayment and recovery program, and debt consolidation is not immune to limitations and disadvantages:
1. Inability to pay off debts – Just because you’re consolidating debt doesn’t mean you no longer have a loan. Instead, you’re taking a new one. Because you still have a loan, there’s still the risk of not being able to pay it.
This inability becomes even more dangerous if you have a secured loan. If you default, the lender can repossess your assets, which can be a home, life insurance policy, or a car.
2. Denial – When it comes to pros and cons of debt consolidation, one of the cons is being denied by the lender. After all, you still have to apply for the program, and the approval depends on your qualifications, including your ability to pay and credit score.
3. Higher interest rate – Debt consolidation also doesn’t guarantee affordable interest rates, especially if you have a variable interest. If the interest in the market goes up, you also pay more on your loan.
Debt consolidation is not for everyone. With these pros and cons of debt consolidation, you can decide whether this is the best debt management plan for you and what questions to ask if you seek the help of a financial counselor or lender.
Are you considering debt consolidation? If yes, let our experts outline for you the pros and cons of debt consolidation.