Debt consolidation refers to the act of taking out a new loan to pay off consumer debts or other liabilities. It is a form of debt refinancing, entailing taking out one loan to pay off any other. This is accomplished by multiple debts being combined into a single, larger debt, such as a loan. This will typically come with more favourable payoff terms including a lower interest rate, lower monthly payment, or perhaps both.
If you are looking to consolidate your debt and pay it off, you could use the equity from your home in order to pay off what you owe. You may use your house as collateral in a secured loan to help pay off your debt, however, using your house to pay off debt comes with many risks and it is therefore important to understand how to consolidate your debt, and your other options in how to pay it off.
What Is Debt Consolidation Useful For?
Debt consolidation can be used as a tool to deal with, for example, credit card debt, student loan debt, and many other financial liabilities. If you are saddled with different kinds of debt, you can apply for a loan to consolidate those debts into a single liability and pay them off. Payments are made on the new debt until it is paid in full.
What Are the Two Different Kinds of Debt Consolidation?
There are two different kinds of debt consolidation loans: secured and unsecured. Secured loans are backed by an asset of the borrower, usually, a house or car, which works as collateral for the loan. If you cannot make the repayment, a lender can withhold the given collateral until the payment has been made. On the other hand, unsecured loans are not backed by an asset of any kind.
The type of debt consolidation loan that you receive may simply depend on your lender and their requirements. Both will likely still have high-interest rates as generally also have fixed rates – this means that the rates will not vary over the repayment period.
Can Your House Be Used in Secured Loans?
A secured loan requires an asset, such as a home or a car, to fall back on if you do not make the repayments to your lender. The most common types of secured loans are auto loans, mortgages, home equity loans, and HELOCs. If you take out a secured loan, you can typically borrow a larger amount of money as you promise to give up your collateral asset to the lender if you are unable to repay the debt. As the lender is taking on less risk because of your promised collateral, they will typically extend lower interest rates and larger limits on your borrowing. Therefore, such loans are attractive to borrowers as secured loans may be easier to secure, especially if your credit score has been damaged.
Selling Your House to Consolidate Debt
You may be able to sell your house to consolidate your debt. Even if you have a secured loan against your house, you may sell it, however you will need to pay the loan back in full before moving. However, selling your property to release equity won’t work for every person who is struggling with debt. Selling your house to pay off debt only works if your home is worth more than the amount you owe. You can figure out how much your home is worth by subtracting your remaining mortgage balance from the property’s market value.
If your property is worth more, selling it may be a way of paying off your consolidated debt. Once you have paid off your debt, you may be able to move. However, it is a risky route and may even leave you homeless. It would be best to talk to a financial advisor to see if there is a way you can avoid selling your house to consolidate your debt.
How Can I Apply for Debt Consolidation Loans?
A common way of applying for a debt consolidation loan is through your bank, credit union, or credit card company. This is the most suitable route for those who have a respectable banking history and a good credit score as, if this is the case, it is unlikely that you will be turned down for a loan.
It is important to note that to consolidate debts and save money, a higher credit rating will result in the best possible rate. In turn, a bad credit score may result in difficulty acquiring a debt consolidation loan.
You may be turned down for a debt consolidation loan if your bank, credit union or credit card company does not believe that you will be able to pay it back. This may be concluded if you have, for example, previously missed repayment dates, which would have contributed to a bad credit score. If this is the case and you hold a bad credit score or banking reputation, you may need to seek other alternatives.
You may wish to explore private mortgage companies or lenders if you are turned down by other institutions. This is because many creditors or lenders will not check your credit score or banking history when reviewing an application for a debt consolidation loan. As debt consolidation maximises the likelihood of collecting from a debtor, a creditor or lender will be willing to overlook banking mishaps.
The Advantages and Disadvantages of Debt Consolidation
Debt consolidation can allow you to pay off multiple debts by taking out a single loan. A benefit of debt consolidation is that this means a single monthly payment can cover multiple payments and a lower interest rate. It is therefore a great tool for people who have multiple debts with high-interest rates or monthly payments – especially those who are over £10,000 in debt or more.
However, although debt consolidation may seem a much simpler way, there are also some disadvantages. Although interest rates and monthly payments may be lower, you must still pay attention to the payment schedule – longer schedules amount to more paying in the long run. If you are considering withdrawing a debt consolidation loan, ensure that you check with your credit card issuer to find out how long it will take to pay off debts at their current interest rates and compare that to a potential new loan.
By consolidating your loans, you risk losing any special provisions on student loans, such as interest rate discounts and other rebates. Make sure that these provisions do not disappear when consolidating your loans.
What Methods of Debt Consolidation Are There?
There are several ways you can lump your debts together by consolidating them into a single payment. Listed below are a few of the most common methods including those which involve your house as collateral:
- Debt Consolidation Loans – many lenders offer debt consolidation loans as parts of payment plans to borrowers having difficulty with outstanding debts
- Credit Cards – you can consolidate credit cards payments into a new credit card or by using an existing credit card’s balance feature
- HELOCs – home equity loans can also be used for debt consolidation
- Student Loan Programmes – the government offers several consolidation options to those struggling with their education finances