If you are wondering, “What is loan consolidation and will it help me?” you are not alone. Banks and loan consolidation companies target people who are struggling to pay their bills with advertising claiming that a loan consolidation can solve all of their debt problems. However, while loan consolidation may help some individuals, it is not always the best solution. Furthermore, there are several types of loan consolidations available, each having unique benefits and disadvantages. Before I go into detail about the various types of loan consolidations and how they may benefit you, I would like to provide you with a clear answer to the question, “What is loan consolidation?”
What Is Loan Consolidation?
A loan consolidation, sometimes referred to as a debt consolidation, combines multiple debts into one monthly payment. This may include credit card bills, medical bills, personal loans and other types of unsecured debt. Typically, loan consolidations are used to consolidate unsecured debts; however, if you have a furniture loan, car loan or other small secured loan, in some cases, you may be able to include that debt in your new loan consolidation. Most people seeking to consolidate their loans are searching for a way to lower their monthly payments and/or interest rates.
Types of Loan Consolidations
The three most common ways to consolidate debts are:
#1 - Unsecured Debt Consolidation Loan
You apply for a personal loan in an amount to pay in full all of the debts you wish to consolidate. However, in order to secure a personal loan with a low interest rate you must have an excellent credit score and a good credit history. Most people pursuing this type of loan consolidation are able to pay their monthly bills but want to simplify their life by having only one bill to pay each month or want to take advantage of a lower interest rate to pay off their debt faster.
#2 - Secured Debt Consolidation Loan
This type of loan requires collateral, in most cases a person’s home, to secure the loan. Some people choose this type of loan consolidation because it is easier to get a secured loan when your credit score is not perfect or because they can get a lower interest rate on a secured loan. However, it is a risky way to pay back unsecured debt. For someone who is already struggling to pay their monthly bills, it may be difficult to make the payments on the home equity loan and they may default. In this case, the lender will foreclosure and sell the home to pay the lien. Again, this option may best serve someone who is financially stable and only wants to lower interest rates, take advantage of a tax credit or wants to simplify personal finances.
#3 - Debt Consolidation Companies
You may have read or heard about these companies and while some may be credible, many are not. In this type of loan consolidation, you enroll with an agency that will negotiate and pay your creditors each month from the monthly payment that you pay to the company. The negative aspects of this type of debt consolidation include paying the agency a fee for their service, thereby increasing the total debt that you owe. Additionally, creditors are not required to accept a negotiated amount or interest rate, as they are required to do if you file a bankruptcy case. For someone considering this type of debt consolidation, a bankruptcy may be a much better alternative.
For example, a Chapter 13 is a 3-5 year debt consolidation plan, but the unsecured debt that does not get paid off during the plan gets wiped out (discharged), tax free! Many debtors that choose Chapter 13 only pay pennies on the dollar back to their unsecured creditors.
Will Loan Consolidation Help Me?
Now that we have answered, “What is loan consolidation?” we can look more closely at how a loan consolidation may be able to help you financially. As discussed above, by combining monthly bills into one payment, you may be able to lower your interest rate. If you are able to pay off the consolidated loan before or within the same time you would have paid off your monthly bills, you will save money by having the lower interest rate. Having one monthly bill simplifies your personal finances and helps you manage your household income and expenses better. A loan consolidation will help if the monthly payment is lower than the total monthly payments of the bills you consolidated. Having one lower monthly payment eases your monthly financial burden so that you can comfortably pay your living expenses and remaining secured debts without stretching your budget too thin.
However, if you are struggling to pay bills each month, a loan consolidation may not be the best solution to solve your financial problems. A loan consolidation does not get rid of the debt - - it just rearranges the debt that you must pay. As discussed above, a debt consolidation company may promise that they can help you by lowering your monthly bills and wiping away debt, but creditors are not obligated to work with the company or with you. In a bankruptcy case, on the other hand, your creditors have no choice but to work within the bankruptcy courts to resolve debt problems. In a bankruptcy, once you receive your bankruptcy discharge, your debt is wiped away and creditors are prohibited by law from taking any steps to collect the debt. A bankruptcy gives you the relief from debt that you need to recover financially and begin rebuilding your finances for a better and brighter future.
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