What are the primary reasons for consolidation of debts? What is to be gained from it? Lesser interest rates, longer repayment periods, no adverse impact and status quo in credit ratings, etc are just some of the benefits, which accrue from debt consolidation. Here's how to tell if you should consolidate your debt.
Firstly, let us consider the meaning of debt consolidation. It is the bunching together or combining of all your debts under a single debt plan so that the number of your repayments are reduced and you do not run the risk of default (due to non-availability of funds on payment date or suffer penal interest). Now, this is effective only if the cost of your debt consolidation plan is less expensive than all the existing debts put together.
This is important! Prior to considering a debt consolidation plan, it is wise to check the viability. There are some loans that carry a reasonably low rate of interest. Most loans given by governments and even private sources, for welfare, agriculture, student/education programs, research programs, commencing business as a small or medium sized entrepreneur, a home loan taken for your first house or any subsidized loans are loans with a low rate of interest. A new debt consolidation plan is unlikely to beat these interest rates. Then, consider the cost for early clearance of debts. Some banks, financial institutions and lenders charge penal interest; sometimes the rigmarole of the whole process, paper work, time consumed, etc, may not make the exercise of debt consolidation worthwhile.
Some experts believe that debt consolidation only works in the case of unsecured debts. Secured debts with good collateral will be well structured in the beginning itself, therefore, any consolidation plan may not bring significant advantages. A notable exception could be if you have taken a secured loan at a very high rate of interest, due to a bad credit rating and subsequently, your rating has improved; or if you have secured better collateral to offer, which has the potential to reduce lender risk and therefore reduce applicable interest rate.
Unlike secured debts, you stand better chances of consolidation in case of unsecured debts. These loans include outstanding amounts on your credit cards, personal loans or hand loans, small cash loans from employer, overdraft or over-drawing arrangements with bankers, store credit and similar loans without any supporting collateral. It is easy and even recommended to consolidate these loans, since they may carry varying rates of interest and the repayment periods could vary too. In such cases, debt consolidation works well and helps in reducing the number of loans against your name, improves your credit rating, reduces the number of debtors and leaves you with fewer payment processes to take care of.
So, the bottom line for considering worthiness of a debt consolidation plan is whether it is less expensive, whether it improves the repayment period and if it helps in improving your credit rating. If your answer is yes to all of the above, only then, would debt consolidation be a right solution for you.