What is a Consolidation Loan?

What is a Consolidation Loan

A consolidation loan is when lots of separate loans are combined into one single loan with one repayment schedule.

People who have a lot of different loans from a number of creditors will often decide to take out a consolidation loan as it is more convenient and it also provides the possibility of lower monthly repayments.

Consolidation loans vary in exactly what they can provide to the debtor, and people take them out for different reasons.

The most common reason behind taking out a consolidation loan is that you have too many loans to pay back, all with different interest rates and the creditors making extra charges. The consolidation loan will get this under control and help you to arrange your finances in a more manageable way.

One thing that you should remember is that a consolidation loan does not provide a way of getting rid of any of your debt. Whereas on other debt schemes, such as the IVA, you have the possibility of writing off some debt in the future, if you have a consolidation loan you will still be expected to pay back the full amount of debt owed, but the way in which you do this will be made easier.

There are different types of consolidation loans. Many people use a basic form of a consolidation loan when they transfer the debt from a number of different credit cards onto one single credit card which has a lower interest rate, thereby making repayments more manageable and affordable.

However, the more common definition of a consolidation loan is when the debtor transfers a number of unsecured loans into a single secured loan. When you have agreed with a creditor to take out a consolidation loan, they will pay back all of your separate creditors the amount you owe, taking on the debt themselves on a secured loan. You then pay back the money to that single creditor at an agreed monthly amount.

As there is less risk involved for the creditor because they have your home as collateral, they will therefore be more likely to provide a lower rate of interest on the consolidation loan than on all the separate loans. To get the lowest possible interest rates it is a good idea to take out a second mortgage with the creditor who provided you with your original mortgage.

A consolidation loan is also a good way to arrange to pay back smaller amounts of money each month, meaning you will have access to a greater amount of income to spend on a monthly basis rather than paying it all back in loans.

However, the danger lies in the fact that once you take out a consolidation loan you will be under a secured loan agreement, and this means you effectively have a lot more to lose. The creditor now has your home as collateral, and this means if you fail to make any of the monthly payments then you run the risk of losing your house.

Pros and Cons of a Consolidation Loan

Consolidation loans represent a good method of controlling your debt and making repayments cheaper and easier. However, the pros and cons have to be carefully weighed up in order to work out whether this is the right option for you or whether you would do better looking into another form of debt management.

Pros

By taking out a secured loan against your house, you will very likely qualify for a lower rate of interest compared to all of your unsecured loans. This means that the debt will not keep on rising and you will be able to keep it under control. If you cannot find a lower rate of interest then don’t bother to take out a consolidation loan as there will be little point.

It is also likely that you can negotiate lower monthly payments through a consolidation loan than you would otherwise be obliged to pay to all of your separate creditors. Lower payments will mean a greater degree of control over what you can spend your income on, freeing you up from the burden of uncontrollable debt and allowing you to spend money on other things.

Paying back a set amount each month also makes it easier to budget. It can become confusing paying back a lot of different cheques each month and it becomes easy to lose track of your budget. Using a consolidation loan allows you to prepare for the future more effectively.

One of the main reasons for taking out a consolidation loan can be the increased convenience of only being in debt to one creditor. This means that not only will you have just the one payment to make, but that you will not have any contact from lots of different creditors with all of their different demands.

Cons

The most obvious risk of taking out a consolidation loan is transferring your debt to a secured loan. Although this does have certain benefits, such as reduced interest and lower monthly payments, there is also a far greater degree of risk associated with this as if you fail to make your monthly payments then you risk losing your property.

Another issue with consolidation loans is that after taking one out, people often forget just why they needed one in the first place, which was often because they spent more than they could afford. You will have to look carefully at your lifestyle and decide whether you are the type of person who will start to spend more money now that you are making lower payments, because if so the consolidation loan could end up being a greater burden than the original debt.

A consolidation loan may mean that you can pay back your debts in smaller amounts, but this could also mean that you will be making the payments over a longer period of time. It could therefore take you a lot longer to pay off your debts, and you may also have to pay back more in the long term.

Are you Suitable for a Consolidation Loan?

The thing that you have to consider before taking out a consolidation loan is whether it is going to help your situation in the long term. Many people who find themselves in financial difficulties because of excess credit card spending will take out a consolidation loan wrongly thinking that it provides the answer to all their problems.

Having to make smaller monthly payments at a lower rate of interest suddenly provides them with a greater level of freedom, and they begin to spend on their credit cards again.

If you think that your financial problems have arisen as a result of an excessive lifestyle of spending, then you will have to be strict with yourself if you decide to take out a consolidation loan, cutting up your cards and refusing to use them until you have paid off the loan. Otherwise you will find yourself getting into even more debt as a result.

It is also important to remember that a consolidation loan does not provide a means of writing off any of your debt. The full amount will still have to be paid back in monthly payments, and if you are in serious financial difficulties and are unable to make repayments each month then you should consider a different form of debt management.

The other major factor to consider is that if you take out a consolidation loan as a secured loan against your house, then the situation suddenly becomes more serious. Now you have put up your house as collateral, you put yourself at risk of losing the property if you fail to make your monthly payments. You therefore have to decide whether you want to take the risk of taking out a secured loan, and if so whether you are certain you can keep up with the payments.

When you go to the bank to take out a second mortgage, you will often be asked to provide details of your finances so that the bank can check that you will be able to make the repayments. As such, you will usually only be able to take out a consolidation loan if you are currently employed and have a regular form of income. If you are on benefits or do not have a job, then the likelihood of you being able to get a consolidation loan is reduced considerably.

Essentially, although there are no strict guidelines as to how much debt you are in and to how many creditors you owe money before you are eligible for a consolidation loan, you should only consider one if you are in debt to a number of different creditors and you are a homeowner or have another form of getting a secured loan. In this sense the consolidation loan is often less restrictive than an IVA or a DMP, but it does not wipe out any of your debt and will not have a fixed timetable for repayment.

The golden rule is to only take out a consolidation loan if you can get a lower rate of interest than you are already paying back. If not, then there is no point in starting one as the risk to yourself is increased through having a secured loan.

About the Author

Rob - Editorial Staff

Rob - Editorial Staff

My Biographical guff is supposed to go here... I am however, a man of few words. But, I do hope you have enjoyed my article (or more importantly found it useful!).

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