Pros and Cons of Debt Consolidation

Debt consolidation means that you can take one huge loan to pay off your smaller multiple loans. Now you may well wonder why take one loan to pay off other loans?

Advantages of debt consolidation

Lower rate of interest

In most cases, a debt consolidation loan is a secured loan, or a loan that is secured with some collateral, for example your house or some valuable asset. The fact that it is a secured loan means that it poses less risk for the lender. In case there is a default in the payment, the lender can sell the asset to release his money. Therefore, a secured loan comes at a lower rate of interest.

Now consider you have several outstanding loans such as credit card loans, medical bills, household bills, rentals etc. All these are typical examples of unsecured loans, which means they come with a higher rate of interest. This is all the more true for credit card loans. If you have ever defaulted on a repayment of a credit card loan instalment, you would know the rate of interest, late fee charges and penalties that are imposed. It is here that debt consolidation can come to your rescue. You take a huge loan at a lower rate of interest to pay off multiple loans with higher rates of interest.

Lower monthly instalments

Secured loans usually have a higher repayment period, which means that you can opt for lower instalments to be paid over a longer period of time. You can have the instalments adjusted according to your monthly salary.

Better control on your finances

Apart from paying higher and variable rates of interest on multiple loans, you also have to deal with multiple lenders and keep track of the various instalments to be paid over a month. All this can prove to be taxing both financially and emotionally. When you consolidate your loans into one, you just have to deal with one lender and one instalment. Needless to say, this means better control over your finances because you don't have to keep referring to your diary again and again for the dates on which you have to pay your instalments. Besides, if you just have one instalment to pay, it means you can budget your finances better. All this means greater financial control and a greater peace of mind.

Disadvantages of debt consolidation

Risk of losing your collateral

All good things in life come with a price and debt consolidation is no exception. First, as already stated, debt consolidation loan is usually a secured loan, which means you stand to lose your asset if you fail to make your payment in time. Suppose your collateral is your house, it goes without saying that if you lose it, you will find yourself in a bigger mess.

Debt consolidation can prove expensive in the long run

Debt consolidation is a secured loan, which means you can opt for lower instalments spread over a longer period of time. What this means is that in the long run, you are paying a higher rate of interest over a long period.

 There are many advantages of debt consolidation but as the saying goes prevention is better than cure. So it is always important to inculcate disciplined spending habits. As a thumb rule, always spend less than what you earn so that your finances are under control and you save enough for the rainy day.