Debts

Debt Consolidation Loans: A Complete Guide

Written by Sukia Akiba

Managing multiple personal debts at the same time is quite tedious especially if you aren’t earning enough to get keep track with repayment. With different due dates and increasing fines for defaults, it would be difficult to effectively clear up your debt.

Fortunately, that is where Debt consolidation becomes an option. Debt consolidation loans offer individuals a way to get out of debt crises through an easy repayment plan.

The good thing is that you won’t have to worry about high-interest rates because most Debt consolidation programs offer low-interest loans. This is why they are still a popular choice in the market today.

In this article, we are going to look into debt consolidation loans and give you an insight as to what to expect when signing up for a loan.

What is Debt Consolidation?

Debt Consolidation is the merging of several debts into a single debt which is paid off by a loan. The loan is repaid with flexible payment plans and lower interest rates. Debt consolidation is quite effective with unsecured debts like credit card debt, utility bills and medical bills.

How Debt Consolidation Works

When you consolidate your debt, you will receive a sum to pay off your current debts. Once that is done, you will only have to worry about paying back the loan you took to pay off the debt. Instead of multiple debt payments and due dates, you will be paying one debt with lower interest rates.

For example, if you have a current debt of $30,000 which includes a two-year loan for $10,000 at 12%, and a four-year loan for $20,000 at 10%. You are required to make a monthly payment of $517 for the first loan and a payment of $583 for the second loan making a total payment of $1,100 per month.

A debt consolidation company will merge both loans and lower your payment to $640 per month while your interest comes down to 9%. This makes it easier for you to repay the loan.

On the surface, it sounds like the best thing to consider if you are deep in debt and unable to pay back with several due dates hanging around the corner. However, there are many things you need to consider before you consolidate your debt.

In the example above, you will be paying $460 less per month including a lower interest rate of 9%. However, it will take you six years to completely pay off your loan rather than 4 years. This means you will be in debt for a longer time.

You will also pay more in the long run than if you had chosen to stick to your original repayment plan.

The main reason why debt consolidation is preferred is that it offers an easier way to repay debt. It is not a faster way to get rid of debt as you would be in debt longer if you choose to consolidate your debt. 

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The Right Time To Consolidate Your Debt

Debt consolidation is not for everyone even if it is one of the best ways to clear up existing debts. If you have a good credit score and you are able to address the reasons why you are deep in debt then that could be the best time to consolidate your debt.

When Debt Consolidation Is Not A Good Idea

It is unreasonably to consolidate your debt just because you are looking for a way to make debt repayment easier. As it turns out, debt consolidation doesn’t mean your debt is eliminated, as you would have to repay the loan you used to clear your existing debts.

If you are yet to identify the reason why you are deep in the debt and unwilling to change your spending habits then you would easily fall back in debt which is worse.

A debt management plan is a better choice if you fall within this category of people.

Debt Consolidation Loans

A debt consolidation loan is a sum provided by the debt consolidation company for the payment of the debt.

This loan is similar to any other loan except that it comes with a lower interest rate which is one of the main reasons why people opt for debt consolidation rather than debt management.

You can get a loan from a bank, credit union or an online lender. Online lenders are the favorite choice as their interest rates are lower compared to the other options listed above.

When it comes to interest rates, your credit score plays a vital role in determining the interest rate you will be charged by the lender.

Sometimes, you would be charged an interest rate higher than what you are already paying for your current debts which could be due to a tumbling credit score. In such a case, debt consolidation is not the best option to consider.

Debt consolidation loans are easily approved when you have unsecured debts, i.e, debts that are not protected by collateral.

Secured debts like home equity debt are more difficult to approve and are considered very risky as you stand a chance of losing your home if you can’t repay the loan. 

How To Get A Debt Consolidation Loan

When opting for unsecured debt consolidation loans it is important you consider only the popular options. Although debt consolidation is a legal way of eliminating debts there are several lenders who aim to scam individuals by offering mouth-watering debt consolidation options.

Watch out for upfront payments before loan approvals, access to bank accounts for withdrawals and quick-fix promises as these are red flags that signal scam debt consolidation companies.

Before applying, ensure that your credit score is within 580 to 739, so that you can get the best interest rates. You will also be required to choose your loan terms which will determine how much you will borrow and the length of time you will be given to pay the loan.

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Finalize your application and wait for the approval. Once approved, the funds will be disbursed to you through a wire transfer, check or direct payment to your creditors. You can begin repaying the loan after receiving the funds.

How to Choose the Best Debt Consolidation Loan Company

There are many lenders offering different options, requirements and loan terms which make it quite difficult to decide on the debt consolidation loan company to go for.

While the popularity of the lender should play an important role when picking a lender, other details like how easy it is to get approved, restrictions and interest rates should also be considered.

Legitimacy

Before choosing a lender, you would want to be sure they are legitimate. Reputable debt consolidation companies have a way of differentiating themselves from the others which makes it easier to single them out.

You can start by checking out the Better Business Bureau which provides information on the accreditation of companies. It also assigns a rating to companies. You can check to see if there have been any complaints or legal actions filed against the company you’re going for. 

You can go further by checking for affiliations. Companies that are affiliated with the National Foundation of Credit Counseling or the Financial Counseling Association of America are considered reputable and trustworthy and could be a good place to start.

Lender Features

Popular or not, it is important you take a good look at the features of the debt consolidation loan company you are opting for. Features like interest rates, repayment options, fees and penalties, loan and refinancing terms can help you decide if the company is the best for you.

Interest Rate

Interest rates play a very big role in choosing a debt consolidation company. However, it is not just about getting a low interest but also about having it stay the same during the period of the loan.

Lenders offer either a fixed or variable-rate loans while some offer both. With a fixed-rate loan, the interest rate stays the same, unlike variable-rate loans which change over time.

With a variable-rate loan, you can start off paying back at a low-interest rate and end up paying something higher than the interest rate of the debt you had cleared.

Loan terms

Loan terms include loan period, minimum and maximum loan amounts, and some restrictions put in place by the lender. Different lenders have different loan terms.

Loan period refers to the life of the loan. When checking the available options ensure that it is not too long no matter how economical it looks. This is because you will end up paying more in the long run.

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Minimum and maximum loan amounts refer to the smallest and largest amounts a lender will offer. It would be anything between $5,000 and $40,000.

Restrictions can be placed on what the loan can be used for. Check the restriction placed by the lender before proceeding with the loan process.

Fees and Penalties

There are several fees charged by the lender before and after the loan has been processed. You can be charged a fee for processing the loan and late fees when you default on payment.

Overall, these fees can significantly increase the cost of your loan. You could end up spending more than you would have if you had just paid the previous loans through the original plan. If your lender doesn’t allow a period of grace before charging a late fee, it wouldn’t be best to go for that lender.

Approval Requirements

When it comes to loan approval your credit score comes to play. Each lender has a minimum credit score that is acceptable before a loan can be approved. Some accept credit scores as low as 580 while others have a higher minimum credit score for borrowers.

A credit score above 650 is good enough and should get your loan approved by most lenders.

Lenders also determine your monthly payment ability through a maximum debt-to-income ratio calculation. The figure realized is just good enough to clear your loan while allowing you to settle other daily bills.

Good credit history should get your loan approved quite easily. Some lenders also require that you have no tax liens, foreclosures, or bankruptcies along with at least three years of good credit history before your loan application can be considered.

Top Debt Consolidation Loan Companies To Consider

1. SoFi

SoFi is a leading debt consolidation loan company offering one of the lowest interest rates and a high maximum loan amount.

With a loan period of 3 years, you can get an interest rate of 5.7% with an estimated monthly payment of $327 (depending on the loan amount). Unfortunately, you will need a good credit score before you can be qualified for a loan.

SoFi has a minimum credit score of 680, however, you would need to have a credit score of 700 or higher to get approved.

It also offers several interest rates from fixed-rates to variable-rates. An advantage of settling for SoFi is that you wouldn’t have to pay processing fees, origination fees, late fees and a number of fees charged by many other lenders.

2. PayOff

PayOff is another great option to consider. Its minimum credit score is lower than that of SoFi’s, however, it has a higher interest rate and higher monthly payment amount. With PayOff, you would only have to worry about origination fees.

Unfortunately, its restrictions and requirements might be too tough for many borrowers. For one, its loans can be used only to pay off credit card debt. Another requirement is that you must have at least 2 years of good credit history and a debt-to-income ratio of less than 50%.

3. LightStream

Lightstream could be the best debt consolidation loan company to consider if you have an excellent credit profile and a credit score higher than 660. It does not charge origination or late fees, however, it doesn’t offer college or business loans.

Conclusion

This guide should make it easier to pick the best debt consolidation loan company. It is advised you make further research on the company you hope to settle for so as to know their current rate and requirements before settling for that company.

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Sukia Akiba

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