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What is the debt consolidation loan? Debt consolidation is a type of loan that is obtained from a lender to settle all outstanding debts today. Obtaining this loan allows you to combine all the monthly installments in a single payment, which must be settled with a new lender. It is useful to decrease the monthly installments, with the interest rate falling as it is obtained for a longer period. There are unsecured debt consolidation loans, as well as secured debt consolidation loans.
Unsecured debt refers to debt that is not linked to any physical or active resource of the borrower in cash. If the borrowers could not settle the debts on time, the lenders do not have any assets that are owned by the borrower to claim the debt. Therefore, interest rates are comparatively higher in unsecured debt consolidation loans. Examples of these loans include personal loans, credit card loans, debt consolidation loans from banks or credit unions.
A secured debt consolidation loan
Secured debt is a debt that is guaranteed by an asset. If the borrower does not pay off the loan, the lenders do have assets to claim the value of the loan. Therefore, interest rates on secured debt are comparatively lower. Examples of secured debt consolidation loans are car loans and home equity loans.
Advantages of the debt consolidation loan.
When considering the advantages of the debt consolidation loan:
- Have a fixed monthly fee to be paid by the lender.
- Having a lower monthly payment, which means more monthly cash flows within a shorter period.
- The interest rate of the consolidation loan is generally lower than the current interest rate.
Disadvantages of the debt consolidation loan
Some of the disadvantages include,
- The debt consolidation loan does not eliminate debts. Only the payment settlement date changes.
- As all loans are transferred to a lender, all debts add up a large number of outstanding payments to be made, therefore, in a way that limits the use of credit cards.
- Almost all debt consolidation loans are secured and, therefore, non-payment will create a great risk of loss of assets that can be attached to the loan.
- As all debts are consolidated, the loan repayment period is stretched and a longer period would lead to settlement of the installments.
The selection of the most appropriate method to be used depends entirely 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, since debt consolidation loans consist of advantages and disadvantages.