Is it better to get a personal loan for debt consolidation?

WeMoney

Can you use a personal loan for debt consolidation? Is a personal loan for debt consolidation a smart idea? Personal loans are increasingly becoming a popular choice for people who are wanting to consolidate their debts.

If you are aiming to pay off your outstanding debt, then consolidating (or rolling) debt into a personal loan is a very effective and easy way to do it. Or, if you are someone who is trying to pay off multiple debts at one time, such as credit cards or car loans, then you can potentially look at a personal loan to make things a lot easier.

Let’s get to the following commonly asked questions:

  • What is debt consolidation?
  • What are the advantages of a personal loan for debt consolidation?
  • What are the disadvantages of a personal loan for debt consolidation?
  • Are there any options aside from a personal loan for debt consolidation?

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Q1. What is debt consolidation?

Consolidating debt is simply taking out a new loan, to cover all your previous debts. The idea is that you will ideally take out a new loan that has a lower interest rate than your other loans so your payments should theoretically be lower. While at the same time, making the process far simpler to manage.

One of the most common ways to consolidate debt is by using a personal loan. When you use a personal loan, you are simply taking out a new, oftentimes, unsecured loan and using those funds to pay down your other debts.

A simple example might be if you have $5,000 in credit card debt attracting a high interest rate and ongoing fees and charges, as well as a car loan for $20,000 with an unattractive interest rate. You can potentially take out a $25,000 personal loan that can pay the other two loans out and ideally that will come with a lower interest rate and potentially lower payments.

While the idea behind using a personal loan for debt consolidation is simple, there are a number of factors that you will need to consider before going down that path.


Q2. What are the advantages of a personal loan for debt consolidation?

When it comes to debt consolidation, there are some key advantages such as better interest rates, payment schedules and improved credit that you need to be aware of to ensure you are making a sound financial decision. Here’s what you need to know.

A better interest rate

Arguably the most important and biggest advantage of a personal loan for debt consolidation is the fact that you can get a lower interest rate than you’re currently paying. A lower interest rate means you will be saving money, compared to what you’re paying now or you could also pay off the debt faster by lowering your repayment amount.

Note: It is important to note, however, that just because you’re taking out a personal loan, doesn’t mean you’ll necessarily improve the interest rate. An unsecured personal loan is generally unsecured debt, meaning it isn’t backed by anything. A car loan, might potentially even have a lower interest rate, simply because it is backed by an asset.

A payment schedule

One of the main reasons people find themselves in debt and unable to manage is that they have never taken the time to get their finances in order.

Most likely, they’ve never really had a budget much less been able to stick to one. When you use a personal loan for debt consolidation, you are effectively creating a new schedule to pay off your debts. This means that instead of trying to keep track of multiple loans and payments, you’re only required to pay off one loan on a set schedule.

Having that locked in a very effective way of not only being able to budget, but it means that you have a clear path to being debt-free. Checking out a loan repayment calculator can give you a quick idea of your repayment options as well.

Note: It is worth noting though, that if you take out a personal loan and want to pay the loan back even faster, sometimes there are fees that come with that.

Improved credit

These days, lenders have access to an incredibly detailed credit history that outlines just how good you’ve been in the past at managing debts.

Lenders only like to lend money to people who don’t actually need the money and as such the better your credit rating the more appealing you’re likely to be to a bank in the future. This is particularly important if you’re ever wanting to take out a home loan to buy a house.

By using a personal loan for debt consolidation you are getting a new, simplified schedule, that allows you to have a very clear understanding of when the repayments need to be made.

Recommendation: Making regular repayments on time can quickly boost your credit rating and these days it is possible to undo some of the damage that might have occurred when you weren’t quite on top of things. It’s one of the main advantages of debt consolidation loans such as personal loans.

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Q3. What are the disadvantages of a personal loan for debt consolidation?

While there are a lot of things to like about how easy and effective it is to use a personal loan for debt consolidation, it’s also worth noting there are some things to be careful of.

Interest rates could be higher

Just because you’re wanting to use a personal loan for debt consolidation, doesn’t mean that it will give you the most attractive interest rate. A personal loan if it is unsecured can still attract high rates depending on your personal situation and credit history.

However, it is equally important to consider the length of time that you’ll be paying off the personal loan. A higher interest rate might not be an issue, if you are intending on paying off the debt faster than some of your other loans.

Recommendation: It is always a good idea to compare all your various debts, the repayments and the fees associated with them to then determine what is the most effective strategy for debt consolidation. Work out how much you’ll be paying in interest in total over the life of the loan and compare that to what you would be paying in your current situation.

Fees and charges

With all lending there are normally fees and charges that can sometimes be hard to see. When it comes to taking out a personal loan for debt consolidation, it is important to look at the costs involved in paying off your loan.

Note: In some instances, the costs involved with paying off a loan early, like exit fees,  might make it a less attractive option. This is often true if you have a fixed rate loan compared to a variable rate loan. Taking out a new personal loan can come with things like application fees, establishment fees, monthly fees, ongoing fees or fees for extra repayments.

Risk of loss

Whenever you are taking out a secured loan of any kind there is always a chance that you could lose the asset that you are using as collateral.

When you take out a personal loan for debt consolidation, there are times when you might use another asset as security and if you don’t make your repayments, then you could be at risk of losing the asset.

Loan term

It’s important to understand that the longer the term or life of the loan, the more interest you’ll pay. A low interest rate might not even make up for a longer loan term, so it is important to calculate not just the loan payments but also the total interest.

Need to qualify

While using a personal loan for debt consolidation is a very effective way to reduce interest and pay off debt faster, you will still need to be able to qualify for a personal loan.

Note: If you originally took out a loan or even applied for a credit card and have since lost your job, it might be more difficult to find a lender who is prepared to offer you finance. Similarly, if you have credit issues or bad credit, this can be tricky.

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Q4. Are there any options aside from a personal loan for debt consolidation?

When you’re looking at a personal loan for debt consolidation there are a number of things you need to consider. The first question to ask is if there are any other options that could work for you?

Debt consolidation and home loans

One of the most effective ways to consolidate debt is to roll the debt into your home loan.

Generally speaking, home loans come with some of the lowest interest rates of any form of debt.

That’s because real estate and property are considered to be one of the safest investments there are and as such, banks feel that they are not taking on all that much additional risk.

If you have property investments or real estate, then it might be worth considering your options and looking at a home loan or some sort of refinancing.

Debt consolidation and credit cards

If you don’t own real estate and can’t get a personal loan, it might be possible to apply for another credit card that comes with a long interest free period. These are normally available for new customers and are simply an introductory offer that a credit card provider offers.

You are then able to make a balance transfer and then work towards paying down the outstanding debt, without the associated interest and ongoing fees that can quickly add up.

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Disclaimer: The author is not a financial advisor and the information provided is general in nature and was prepared for information purposes only. This article should not be considered to constitute financial advice. Accordingly, reliance should not be placed on this article as the basis for making an investment, financial or other decision. This information does not take into account your investment objectives, particular needs or financial situation.

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