(This article was originally published on the 7th of February 2019 and updated on the 24th of October 2019).
The biggest cargo people carry these days is debt. Borrowing, including the use of credit cards, is habit-forming. Once you get caught in the habit, you run the risk of spending more than you can really afford. When your loan balance begins to rise, it becomes a heavy burden.
Dealing with an enormous amount of debt comes with the feeling of fear, guilt and shame. But you can avoid getting to this point if you manage your personal finances and debts well. Otherwise, you need to act fast or the situation can get out of control. Your possible remedy like many others with the same problem is debt consolidation.
What is Debt Consolidation?
Debt consolidation is a type of loan you obtain if you want to merge multiple loans. For people deep in debts, it serves as a debt-relief. The lender will combine all your outstanding loans and book them in a single account. The objective is to bring down the interest rate and hence a more reasonable monthly repayment for an extended period.
Debt consolidation is similar to debt restructuring although the two options are different. When you are consolidating debts, you sign new loan documents for a new account. The total sum of all your outstanding loans become the principal amount of the fresh loan which is charged with a same interest rate.
The interest rate of the consolidated loan should at least be lower than the average rate of your existing loans. That is to ensure the resulting monthly loan repayment is within the limits of your affordability.
When Should you Consider Debt Consolidation?
There are signs that would tell you when you should be considering debt consolidation. The most obvious is when you begin to miss paying credit card bills or other loans on due dates. Your loan balances compound with the added penalties and finance charges imposed due to late payments.
You run the risk of credit card suspension and lose creditworthiness. Aside from a low credit score, you throw away your spending power. And you end up with a bucket full of debt.
Debt consolidation is also a way of protecting and maintaining your good credit standing. You are given the chance of redeeming your creditworthiness if you can make timely payments on the loan.
What are the Factors for Consideration?
Before deciding on consolidating your debts, know the important factors for consideration. Carefully evaluate if the personal loan will put you on solid footing. You do not want the situation to be worse than before.
1. Conduct Due Diligence on Yourself
Panic will grip you in this situation but you need to remain focused. Have you reassessed your actual financial condition and exhausted all possible means? Take time to evaluate your ‘actual’ cash flows before coming to a conclusion you need to consolidate your debts.
Sometimes all you need to do is improve your budget planning. Revisit or prepare a new budget, list down in detail all funds coming in and out. Reallocate the budget on some items and earmark excess funds for loan payments.
In case there is really no room to gain extra after your comprehensive evaluation then you can pursue a debt consolidation plan.
2. Look for Better Interest Rates
Let us assume you that have two outstanding loans in need of consolidating. A short term unsecured loan personal that is 8% p.a and a credit card debt of 18% p.a. Hence, the average interest rate comes out to 13% p.a.
Thus, what you should be looking for is a loan that offers a rate which is lower than the said average, so that you can lower the interest you are paying for your loan. Let us show a calculation example:
|PERSONAL LOAN||CREDIT CARD||CRITERIA||PERSONAL LOAN|
|8% p.a.||18% p.a.||INTEREST RATE||4.9% p.a.|
|3 years||2 years||LOAN TENURE||3 years|
|SAVE = RM205 monthly|
From the table depicted above, you can save roughly RM205 monthly. By converting that to 12 months, you can save RM2,460. If you are a civil servant, you can take up a Public Bank Personal Loan that is currently offering an interest rate of 4.9% p.a. Moreover, a fixed-rate personal loan is ideal for budgeting and monitoring purposes. You know exactly the amount you need to set aside to pay the lighter monthly loan repayment every due date. The lower interest rate is the primary reason why you should opt for debt consolidation.
However, do not expect all lenders to apply uniform rates. Sometimes the rate will depend on the borrower’s credit score. If getting lower rates is improbable, defer your plan. It defeats the purpose of consolidating debts. You will be creating more debt than solving your problem. In the meantime, improve your payment habits until you can find a suitable personal loan provider.
3. Know the Processing Costs, Fees and Hidden Charges
Do not be misled by lenders that guarantee the lowest rates and most convenient payment periods. Know the details of the personal loan such as processing fees and related charges. Moreover, beware of hidden charges.
Also, longer payment terms mean higher interest cost. So you should arrive at the ideal loan tenure aligned with your paying capacity. The sooner you can fully pay the loan, the earlier you can achieve peace of mind.
The Downsides of Debt Consolidation
Debt consolidation is an effective tool to help borrowers climb out of the debt quicksand. However, there are also downsides when you consolidate debts through a personal loan.
Longer Repayment Offsets Low-Interest Rate Advantage
For an individual with a lot of debts, only lower interest rates and extended payment periods will make it possible to meet the loan commitment. You will be swimming in debt quite lengthier while paying higher interest cost in the end. In effect, the extended period virtually erases the low rate advantage.
Probability of Rejection
There is a higher probability of rejection if you have a low credit score when applying for debt consolidation. Due to your current commitment, you might be offered a less favourable terms compared to if you are in a healthier credit position.
Will not Eliminate Debts
Debt consolidation can either work for you or destroy your credit reputation. The new loan does not absolve you of the responsibilities to make prompt and timely payments. The debts remain collectible until it reaches zero balance.
Some borrowers do not learn from their mistakes. Unless you change your behavior and exercise discipline to win back creditors’ trust, you will be years away from financial freedom.
Find the Real Deal
Applying for a personal loan to consolidate debts is the only route particularly for those with unmanageable loan commitments. But finding the real deal is tough. Deal only with a trusted and dependable personal loan provider to help you straighten things out for good.
If you have decided to use a personal loan to pay off your credit card debt, check your Personal & Koperasi Loan Eligibility here online – Fast, Simple, Safe. Direct Lending is an online personal lending to assist you to search and apply for the personal loan that best suit you.