What is a Debt Consolidation Loan and How Does It Work?

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Taking up loans is not bad, especially when it is taken for the right reasons and is mainly used to sort out urgent financial problems or investments. However, with so many financial obligations, people will always be tempted to take up several loans, from education to car loans to house mortgages, which attract different interest rates.

However, therein lies the problem. Sometimes, the loan interests can be overwhelming such that individuals fail to keep up. This is where loan consolidation comes in.

Today’s article will provide a definitive guide to what Debt Consolidation Loan is all about, how it works, and all the essential aspects that will help you make informed financial decisions.

What Is A Debt Consolidation Loan?

Imagine repaying five loans, each attracting a different monthly interest rate while in a precarious financial position. It can be very overwhelming and challenging. In that case, you should start thinking about consolidating your loan debts.

A debt consolidation loan is one of the quickest ways to refinance your loan debts. It requires you to take up a single loan to pay off all your other existing loans and then start repaying the single loan based on agreed terms with your loan consolidation partner.

How Loan Consolidation Works

Assume you have three loans, a personal loan with an interest rate of 15%, a home mortgage with an interest rate of 25%, and an education loan with an interest of 10%, bringing your total interest cost payment per month to $2,000.

With loan consolidation, you can reduce the total interest cost by half, assuming the new consolidated loan is given at a lower interest rate. In the end, the loan consolidation company will provide you with the loan based on their terms to help you clear your existing loans and then make monthly payments to them to clear the single loan.

Loan Consolidation Companies

With the rise in loan uptake due to financial pressures, many people require loan refinancing to have an easy time repaying their debts. Several companies now exist that offer loan consolidation services.

However, they each vary in terms of the services they offer. The best debt consolidation loan companies include SoFi, Upgrade, Credible, Upstart, LightStream, OneMain Financial, and Best Egg. If you have a bad credit score, you can seek OneMain Financial’s services.

How To Apply For A Debt Consolidation Loan

Applying for a consolidation loan pretty much takes the same process as the typical bank loan. However, the process requires several legal works you will need to complete.

First, you need to understand your finances with more focus on your credit score. The better your credit score, the better you stand to get a reasonable interest rate consolidated loan.

Second, ensure that you compare the lending terms of the available loans by the different consolidated loan companies. Pay attention to the loan fees and the loan interest terms. Finally, ensure you have all the required loan application requirements, such as recent pay statements, bank statements, or tax returns.

Benefits Of A Debt Consolidation Loan

If you’re looking to save money, streamline your monthly payments and circle the payoff date on your calendar, then debt consolidation may be a good fit. Debt consolidation has several benefits.

First, you can get loans to help you pay off debt faster. Paying different loans at a time can stretch your loan repayment for many months, but that is shortened with a consolidated loan.

Second, with a consolidated loan, you stand the chance of reducing your loan interest costs if you get a lower interest rate compared to your current cumulative loan interest cost. Third, managing one monthly loan payment is more manageable than multiple payments on different dates, which can help you manage your monthly income better.

Risks Of a Debt Consolidation Loan

Despite loan repayment flexibility, the debt consolidation loan has several downsides.

The first is that it won’t solve all your financial problems not unless you adopt positive financial habits such as minimizing expenses.

Second, if you are not careful, you might end up paying excess upfront fees such as origination fees, balance transfer fees, prepayment penalties, and annual fees, which can make the consolidated loan expensive.

Finally, depending on your credit score and income statement, you may get higher interest than your original cumulative loan interests, which would also make your consolidated loan expensive, especially if it is stretched out for many months.

To calculate the savings on your debt, try using a credit card payoff calculator and a personal loan calculator such as the one on Sofi and Upgrade platforms.