Introduction
Nowadays, one can get a loan for any use, including buying a house, paying for the higher education of children, starting a business, or simply going on vacation. In addition, there is no limit to the number of loans one can take out. It is possible to borrow for both personal and business purposes.
Although this allows easy access to funds, taking out multiple loans is not a good idea. It is still a debt. As the number of loans increases, so does the responsibility. Many people take multiple loans and then get stressed about repayments. Keeping track of multiple payments is another hassle.
A solution to this is debt consolidation. It consolidates all the borrower's debts into a single debt. A personal loan is an excellent option for the consolidation of debt. Today, banks and financial institutions offer quick and easy personal loans with attractive interest rates. Some even specialize in loans for bad credit.
This article will explain the pros and cons of personal loans for debt consolidation.
What is the meaning of Debt Consolidation?
Consolidating debts is a popular debt management strategy to pay off your existing debts and become debt-free. A high debt burden adversely affects income and finances. It also negatively affects credit scores, which leads to higher interest loans on the new loan.
The primary goal of consolidating debts is to combine multiple high-interest rate loans into one low-interest rate loan. It is a perfect solution for people who have taken on a lot of debt and need an organized solution to manage their finances.
What are the Pros and Cons of Debt consolidation with a personal loan?
Personal loans are usually unsecured loans that the borrower can use for any purpose. One can use a personal loan for credit card consolidation or any repayment of any other debts.
Thus, the final use is not restricted. In addition, these require minimum documentation and are approved faster.
Here are the pros and cons of using a personal loan for consolidating debts:
Pros:
- Organised accounts:
As said before, multiple loans offer easy access to funds. However, the borrower needs to take care of the repayment of bills and interest due dates. If borrowers fail to pay these on time, they will be liable for interest and a penalty. Further, the default damages the credit score. The higher the number of loans, the higher the stress of remembering the due dates. With the consolidation of debts, the borrower only needs to be concerned about one personal loan payment in a month. Hence, the accounts are better maintained and organized. It lowers the risk of penalties.
- Low-interest rate:
Personal loans are a popular option for obtaining access to funds at a low-interest rate. In contrast, other specific loans, like home loans, may have a higher interest rate. If the borrower's credit score is high, his loans may have a high-interest rate. With personal loans, borrowers can opt for a lower interest rate.
- Faster debt-free option:
With a personal loan, borrowers will have a fixed repayment schedule. It is agreed upon at the time of applying for a loan. It will also help the borrower calculate when they will be debt-free. The borrower can also try and prepay the loan in full. However, before doing so, borrowers must check if the lender charges any fees for the prepayment of the loan. Try discussing that at the time of applying for a loan.
- Better credit score:
A credit score is a representation of the creditworthiness of the borrower. Taking on multiple debts and defaulting on payments can adversely affect the credit score. Personal loans can help improve that. With personal loans, borrowers only need to keep track of a single monthly payment. If they pay on time, they can build up their credit score. Also, if the borrower requires consolidation loans for bad credit, they must first monitor their credit score before applying. Many lenders offer free tools for this purpose.
- Higher savings:
With personal loans, borrowers can discuss a repayment tenure schedule and interest rates with the lender. If the term is longer, then the payments will be divided accordingly. It will automatically reduce the monthly expense of the borrower. Further, by consolidating debts, borrowers can become debt-free faster. It will also increase their savings.
Cons:
We have understood how personal loans are a good option for consolidating debts. However, there are some disadvantages to it as well. Here are a few.
- Higher interest rate:
A debt consolidation strategy is suitable only if the borrower receives a lower interest rate on the new loan than on existing loans. If this is not the case, then it is not worth it. With multiple loans, credit card bills and a low credit score, it may be possible that the borrower does not qualify for a low-interest rate on the personal loan.
- Fees and charges:
In addition to interest rates, personal loans may come with loan processing fees, annual maintenance charges, application fees and GST. Further, if the borrower wants to pay off the loan early, the lender also has prepayment or cancellation fees. Some lenders also charge for duplicate statements. When we consolidate all these charges, these can be much higher compared to the borrower's existing loans. Thus, one needs to analyze and review the terms and conditions while applying for a personal loan.
- Chances of higher debt:
Managing one's finances requires discipline. If the borrower spends more than their income, they will always keep taking on more debt. One needs to remember a personal loan is for paying off all the existing debts and becoming debt-free. It is not for overspending or taking on additional debt with an extra line of credit. Hence, borrowers must address their habits and maintain discipline while managing their finances.
- Long-term blockage of funds:
With a personal loan, the borrower may enjoy a low-interest rate and, with a long repayment tenure, save on monthly expenses. However, if the tenure is longer, then one needs to keep paying interest for that much time.
- Collateral risk:
Some lenders may want security in exchange for a personal loan. If the borrower defaults on the repayment or interest, they will put their asset at risk.
In a nutshell
After reading the above article, you will understand the pros and cons of consolidating debt with a personal loan. However, before applying for it, the borrower must ensure they have sufficient income inflow to pay off the new loan.
Defaulting on the payment of a new loan can be more damaging to the borrower. Some lenders also offer the option of a debt consolidation calculator online. In addition, before applying for a personal loan, review all existing liabilities, determine how much loan you want, and carefully research different lenders. In case of any queries or doubts, always consult a financial advisor.
01 July 2022
6 mins read
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