Let’s Talk Debt Consolidation: How Does It Work?

As the financial space evolves, debt — be it personal or commercial — has become an indispensable leveraging tool for achieving desired aims. It is commonplace for a household to have multiple sources of debt from various lenders or creditors. From settling a student loan repayment to financing a purchase of a vehicle, people and corporations can be juggling multiple debts at any given time.

However, tracking all your debt can get confusing and stressful, even with proper management.

If you find yourself nodding in agreement to this, I have good news for you! There is a way to make multiple debt payments a singular and seamless process; debt consolidation!

Keep reading to find out just what this process is all about and how you can use it to make your life easier.

Debt Consolidation: The Basics

As the name suggests, debt consolidation refers to the process of merging (consolidating) multiple debts into a single, aggregated debt. Instead of paying several debts at varying dates, debt consolidation allows you to pool all your debts into one payment to a single lender, ideally at a lower interest rate. 

Debt consolidation can be used to pool debts such as auto loans, credit card payments, medical debt, payday loans, personal loans, student loans, and others. 

Now let’s be clear; debt consolidation is not a magic wand you can use to erase your debt at once. But it is a strategy that can make debt repayment easier and potentially cheaper.

Depending on how big your debts are and the structure, you can save hundreds or even thousands of dollars by paying lower interest. Debt consolidation can also help simplify your debt payment schedules. With only one debt to worry about, the chances of you forgetting to pay a debt on time can reduce. And this improves your credit score! 

Debt Consolidation Types

Broadly speaking, there are two kinds of debt consolidation loans. They include secured and unsecured debt consolidation loans. 

Source – Google Images | Secured and Unsecured Debt

Secured

With this type of debt consolidation, the lender uses a tangible asset of yours, like your house, as collateral, to back the debt. If you, the borrower, is unable to repay the loan, the lender can sell the tangible asset to recover the funds owed.

Secured debt consolidation loans typically come with lower interest rates than their unsecured counterpart, as there’s almost no risk for the lender. Essentially, the borrower bears all the risk.

Unsecured

As opposed to secured loans, unsecured debt consolidation loans are not backed up with any tangible asset. To assess how much riskier this kind of lending would be, the lender will use the information on your credit report to assess how reliable you are as a borrower. With this method, failure or delays in loan repayments will damage your credit score and thus make it harder for you to get new loans or do debt consolidation. So make sure you repay on time!

Requirements for Debt Consolidation

By now, you must have figured out that creditworthiness (your credit score) plays a crucial role in securing debt consolidation. Having a stable source of income is another important metric lenders evaluate in assessing potential customers.

While the documentation needed might vary based on your credit history or lender, the most common document requirement for debt consolidation include an employment letter, a two-month statement for each credit card or underlying loan, and letters from creditors or repayment companies. 

After the debt consolidation plan is set up, the next course of action would be to select which debts you want to pay back first. Essentially, deciding on a priority order. This is usually decided by the debt consolidation facilitator or lender.

Logically, it makes sense to make the highest-interest debt top priority for paying back because that is the one that would cost you the most interest.

When to Consider Debt Consolidation

While debt consolidation brings notable ease and other advantages to pay off your debt, it is good to ask yourself if it’s necessary after considering the reasons you got into debts initially. For someone in a more stable financial position with predictable and sustainable cash inflows to pay off debts, opting for debt consolidation may make sense.

Source – Shutterstock | Using Debt Consolidation

In some scenarios, it may be wise to hold off plans to consolidate your loans until you’ve secured the highest achievable credit score.

Of course, debt consolidation is only a good idea if you have the discipline to use your credit cards wisely without overspending. If not, you could accumulate more debt than you started with, causing instability and a strain on your budget. This could cause you to default on your repayments and hurt your credit score. 

How to Consolidate your Debt?

Described below is the standard procedure for consolidating debt:

Secure prequalifications

Many lenders allow you to examine their loan offers and other necessary information, such as the loan amount, loan terms, attached interest rates, loan fees, and expected monthly payments. Once done, proceed to your preferred lender’s website and get prequalified for the loan.

Compare Offers

After securing a position with a lender, it’s a good idea to get your hands on at least three loan offers to compare them and discover the loan package that gives you the best offer. One of the main considerations is to minimize the interest rate paid.  

Get Your Documents Ready

As mentioned in the ‘requirements’ section of this article, lenders usually request certain documents from potential customers to evaluate their creditworthiness and other useful information. Make sure to have all documents at hand before and upload them on the website where necessary.

Submit Formal Application 

After cross-checking all the details and entries for errors and omissions, submit your formal applications.

Pay Off Your Balances

Start the debt consolidation and pay off the balance to your lenders or creditors in a timely and organized manner.ments.