What is Debt Consolidation Loan? It is a type of loan that is obtained from a lender in order to settle the all the outstanding debts at present. Obtaining this loan enables to combine all the monthly installments into a single payment, which needs to be settled to a new lender. It is useful to decrease the monthly installments, with the lowering interest rate as it is obtained for a longer period. There are unsecured debt consolidation loans as well as secured debt consolidation loans.
Unsecured Debt Consolidation Loan
Unsecured debt refers to debt that is not attached to any physical resources or assets of the cash borrower. If the borrowers would not be able to settle the debts on time, the lenders do not have any assets owned by the borrower, in order to claim for the debt. Therefore, the interest rates are comparatively higher in unsecured debt consolidation loans. Examples of these loans include personal loans, credit card loans, bank or credit union debt consolidation loans.
Secured Debt Consolidation Loan
Secured debt is debt that is secured by an asset. If the borrower does not settle the loan, the lenders do have assets to claim for the value of the loan. Therefore, interest rates in secured debt are comparatively lower. Examples of secured debt consolidation loans are car loans and home equity loans.
Advantages of debt consolidation loan
When considering the advantages of debt consolidation loan:
- Having a fixed monthly installment to be paid for the lender.
- Having a lower monthly payment, which means that more monthly cash flows within a shorter period.
- The consolidation loan interest rate is usually lower than the current interest rates.
Disadvantages of debt consolidation loan
Some of the disadvantages include,
- The debt consolidation loan does not allow to eliminate debts. It only shifts the date of settling the payment.
- As all the loans are shifted to one lender, all the debts add up to a huge amount of outstanding payments to be made, therefore, in a way it limits the usage of credit cards.
- Almost all the debt consolidation loans are secured, and, therefore, failures to make the payments would create a huge risk of losing the assets that may be attached to the loan.
- As all the debts are consolidated, the payback period of the loan is stretched and a longer period would take in settling the dues.
Selecting the most suitable method to be used totally depends on the type of situation an individual faces. Therefore, before adopting any of these methods, it is better to analyze the impact of these methods and then select the best option as the debt consolidation loans consist advantages as well as disadvantages.
- Needles et al (2011) Principles of Accounting, Nelson Education Ltd
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