Debt Consolidation with a Personal Loan: Is It a Good Idea?
Managing multiple debts can be a challenge and can even cause an overload on your overall financial situation. Therefore, it is important to devise strategies that can help you effectively handle the existing financial obligations and avoid the accumulation of debt. One option that can come to your rescue is debt consolidation with a low-cost, long-term personal loan.
In this article, we will examine debt consolidation and how to make the most of this financial tool. We’ve also included examples to help you better understand. It will help you evaluate your situation and decide whether you should consider debt consolidation.
What is debt consolidation?
As the name suggests, debt consolidation combines all your current debt into one unit. This new loan requires you to pay only one EMI instead of making 3 to 4 monthly payments separately. It comes with a fixed interest rate and EMI over a specified period of time. This usually lasts from 1 to 5 years. After consolidating your debts into one, you can also clear your dues in a short span of time with a single payment every month. So, no more missing out on paying EMIs and paying penalties.
Is it a good idea? What are the benefits of consolidating debt?
If you have high-interest loans to pay, then consolidating debt is a good option. This is viable only if you have an improved credit score since you’ve applied for the original loans. If your credit score isn’t high enough, you may not be able to get a loan at a lower interest rate. So, in this case, you may not consolidate your debts. Also, you must take into consideration the reasons why there is an accumulation of debt. Is it because of overspending? This is because paying debts with a consolidated loan is not rational to stockpile your dues again.
Benefits of debt accumulation
Considering debt accumulation can have multiple benefits, such as:
- Streamlined management of debts
- Decrease your overall interest rate
- Better control over your finances
Does debt consolidation affect your credit score?
The impact on your credit score after debt consolidation depends on your repayment action. If you pay bills timely and consistently, you have a better finance management strategy, which is likely to reflect positively on your credit score. On the other hand, if you miss dues, your credit score will have a negative impact.
Additionally, the new loan application will temporarily cause a dip in your credit score due to hard credit inquiry. However, debt consolidation may improve your credit score over time. If you settle your revolving lines of credit, the credit utilisation rate will reduce. The ideal credit utilisation rate should be less than 30%; debt consolidation can help you accomplish this quickly. So, making consistent, timely payments will help you pay off the debt and improve your credit score.
Types of debt consolidation with examples
- Multiple loans: In this scenario, you can combine two or more personal loans into one larger one and make a single payment monthly. It helps you manage debt while enjoying the benefits of reduced interest rates. Let’s say you have 3 personal loans. Each has different due dates, interest rates and monthly payments. The 3 can be combined into one sum with debt consolidation.
- Multiple credit card bills: This means that you can merge the credit card balances into one payment and get a personal loan at a low interest rate. For instance, if you have 2 credit cards with dues ₹90,000 and ₹50,000 respectively. The interest rates and minimum payments for each card are different. But with debt consolidation, you can get a personal loan of ₹1,40,000 and pay all dues by making a single monthly payment.
- Two types of debts: This is a combination of the above two. Here, you can combine credit card balances and personal loan debts. Suppose you have a debt of ₹10 lakhs to pay, but the debt consolidation is only available up to ₹8 lakhs. In this case, you must prioritise which loan to pay off first, i.e., high-interest debt.
Endnote
Whether you want to consolidate your personal loans or business loans taken from a small finance bank, there are certain factors to consider before making a decision. Check the interest rates, processing fees, loan term, lender reputation and impact on credit score to see if it’s a feasible option for you to consider consolidating your debts.