Debt Consolidation

It is a form of debt refinancing that entails taking out one loan to pay off many others.

Debt consolidation is how a person reduces the number of loans taken by him to a single huge long-term loan. It is taken by the people to consolidate the number of loans into one loan.

It sounds very relaxing to the people who cannot manage their loans and credit card bills and cannot remember the due dates, etc., just like waving a wand to reduce the stress regarding this.

Wait, let us see and understand it from its basis to its advance, learn about its pros and cons and how to use it, whether it is right for you or not; then you can make decisions on your own.

So, debt is something you possess right now that someone else owes you. So, it means something you have that is owed or due to others, generally, the money you have taken from others that you have to pay them.

It can be of many types based on its nature, like time duration, secure by collateral or not, the purpose of taking it, and modern ways like credit cards, spit cards provided by NBFC and pay later schemes, etc.

Consolidation is an act or process combining several things into one. It is generally used to curdle stuff into one, like combining the data in a particular place like in excel.

So Debt consolidation is an act or process of reducing the number of loans into a single long-term huge loan so that people can pay their debt in case they cannot pay or manage them.

After COVID-19, this industry boomed in the market, and the growth in this industry is exponentially high, with market size of millions of USD.

Generally, it is not easy for people to manage their multiple loans and give interest to all, as it becomes too much of a concern that people are unable to pay their debt at the due time, and because of that, interest increases which raises the burden.

It generally happens with people with bad money and debt management skills or for someone with huge medical, property, student loans, or sometimes credit card bills that they cannot clear due to financial issues.

Not only does it concern people, but it also applies to countries such as the recent situation in Srilanka. This country takes many loans from China for development purposes, but they have now become unable to pay. In this case, they owe China a huge amount of money, which is a loan. 

Understanding debt consolidation

Ṣo, one question will come to mind: 'why do the banks give to the people if they cannot manage their debt and money?'. 

As we all know, banks are not famous for their charities, so why are they giving these types of big loans to the people who are already unable to pay their loans, and why are people also taking it as most of them are already defaulting on their payments? 

What are the reasons behind banks giving these consolidation loans?

First, you need to understand that these loans can be taken from many sources like banks, credit unions, financing companies, a creditor, and family and friends, so it is not only about getting them from banks.

Secondly, we need to consider that banks are also businesses that give loans to people to earn interest, and if the amount of money is big, then the interest is also big due to the duration of the loan. 

Bank does not give loans to all of them. They provide loans for those who fill their criteria. One of those criteria is good credit, which means the people who have good credit in the past and want to take this loan because of something wrong.

 Moreover, sometimes people's loans reduce the stress of paying loans on the due dates. So it is more like an exit for them to reduce the number of loans into just one so that they have to pay it by one due date.

One more criterion to this is the size of the loan is massive like health loan, property loan, education loan for any loans which are of big amount generally so that they can earn a good amount of interest in the long term.

So firstly, people find the right bank or source from where they can take this, considering the interest they have to pay and the duration of it so that they can find the most suitable ones.

Then they check out the eligibility criteria of the source from where they are taking this loan and whether they can meet all those terms and conditions and are ready to qualify for it.

Then, if the source is banks or NBFCs, you will submit your documents, and they will start verifying it and checking where you can meet the qualifying requirements for taking it from them.

You will apply for the loan, and they will come to check your profile and then tell you how much loan you are eligible to take and if it clears your needs. 
If both agree on the same terms, then the loan is passed, and the person will know monthly payments, the duration of the loan, and the interest they are paying for getting it.
This loan will be consolidated into just one single loan where you have to pay it per the terms given by the source, and you will have only one due date every once in a while as per the loan conditions, which can be monthly, half-yearly, or annually.

It sounds easy when I am typing this, but it's not. It is tough to get it, and most of the time, people, due to bad credit history, cannot get it, but for those who got it, it is an excellent chance to reduce their debt pressure if used wisely.

It does not mean you don't have to give any loans if all your debt is cleared. However, it implies that by giving EMIs for many loans, you will pay for one huge loan covering all your previous loans.

It means all the debt is transferred to one account or place. It does not mean you are rid of them. Instead, you must pay them to be cleared from their debt trap. Some examples are given below.

Example- 1 Suppose a person has a car loan, property loan, credit card bills of 4-5 cards, and his total liabilities is 500k; then he takes one consolidated loan of 500k, then he has to only one EMI, then 6-7 EMIs and bills.

Example- 2 Suppose Mr . A has more debt and is unable to make payments timely due to some financial issues, so he takes a loan that contains the remaining amount of all loans he has taken previously. 

Types

Until now, we have known about this process, how it works, how a person can take it, and its advantages, which tells us why people nowadays consider it.

So this industry boomed recently due to an unfortunate event in human history, the COVID-19 pandemic. Why? Because of a sudden rise in the medical emergency and unemployment rate, etc.

People do not have money for their medical and regular household expenses and start defaulting on their EMIs, credit card bills, and many more, which makes people bankrupt.

Now people have started using this way to reduce their obligation towards others' money, but they do not know which type of loan they get for consolidation or what kinds of it they will get from the bank.

So mentioned below are the type of loans for consolidation that a person can get from the bank and different NBFCs:- 

1. Non-secure loans:

Generally, debt consolidation is divided into two loans which are non-secured loans and secured loans. We already know that those not secured by any collateral are known as non-secured loans.

In simple words, these are the loans given by the bank or NBFC to the people without asking for any securities in return, which means people do not have any collateral or property on behalf of the loan.

These loans are generally given to those with a good credit history, and banks trust that they will pay them back without any problem. These loans are also small amount loans.

Generally, banks do not give this type of consolidation loans because there is a huge chance of these loans becoming NPA (non-performing assets), so they are only offered to highly trusted people.

2. Secured loans:

Banks' loans are secured by collateral so that if the person cannot pay the loan in the future and becomes an NPA, the banks can recover their money from collateral.

Generally, the amount given as a law is 50 to 60% of the collateral offered by the person to the bank while taking these loans so that the bank can earn money from it and not lose money.

Usually, banks give this type of loan because it is more secure for banks to provide them with this instant of non-secured loans. Moreover, the bank can recover money in the worst scenario.

Mentioned above are the two types of loans that banks give in the case of doing consolidation so that as per the credibility of the person, they can get the respective loan to take advantage of this process.

These loans are categorized based on collateral, but they can be used for many purposes, like student loans, mortgage loans, or credit card loans, depending on the individual taking them.

Advantages

So that is how the whole system works. But, yes, it is time-consuming and sometimes frustrating for the people interested in taking it, which is why many people do not want to take it.

For some, it is a big step for reducing their overall liabilities from their shoulders and reducing stress; for some, it is a chance to increase their blood pressure by taking huge loans to their small ones.

But there are many positive points to consider as it is not all bad if you focus on repaying your advances and thinking of taking it, which is why people accept or believe this a lot from the other options. 

There are some advantages that a person can consider if they are thinking of taking it and why it benefits them. To answer that, some points support it given below it:-

1. Repay debt early:

One of the biggest advantages of this type of loan is that it helps pay the already taken debt early. By taking this, you will be able to pay your debt more early than in the maturity period. 

Suppose you have a property debt for your house for 20 years for a principal amount of 500k for an interest of 6% annually so that that total amount will be $ 8,59,717.

After that, you have taken up consolidation, which covers all of your previous loans, including your house loan. After consolidation, they have paid your home loan directly, so the interest amount decreases.

That's how this loan helps reduce a person's total liability.

2. Simplify finance:

It has been simplifying finance for normal people. It helps them manage their liabilities by decreasing the number of loans to a single loan with a single due date at a particular time, as per the instruction. 

It allows people to reduce their tension regarding the frequent due date payments for each loan and make it easier to manage their loans by combining them into one long-term loan.

People prefer this because it gives them flexibility and convenience and releases all the tension about the inability to pay payments.

3. Having a fixed repayment:

Every loan a person takes has repayment policies, EMIs, and ways to pay their loan. But by taking this type of loan, if the repayment of the loan is fixed, you do not need to track many but one.

It means that by taking these types of loans, you will have to pay for one loan, not all the loans you have taken, which reduces the person's time and effort and is also peaceful for the person's mind.

It becomes much easier to track it when you need to track only one loan instead of many loans, which is stressful as you need to remember all the due dates of the loans taken respectively.

4. Boost credit: 

These types of loans are long types of loans in which you take the loan for a huge amount generally, for a more extended period, in less interest than the interest you have been giving earlier.

That helps increment your credit score as you have been able to pay a large loan at the right time, increasing your creditworthiness and credibility in front of banks.

It increases the credibility and goodwill of a person as a loan taker in front of the banks, which increases the person's credit score as they are taking the long-term loan and paying the installment before or on the due date.

So we can say that there are many advantages of doing debt consolidation: it helps repay the previous loans in advance, decreasing the interest rate they have to give in the future. 

It simplifies finance for the loan taker, decreases the loan interest as a long-term loan, makes a fixed repayment scheme where you don't need to remember many due dates, and boosts credit.

It also reduces the stress and tension about the different loans taken previously. Also, it makes it convenient and flexible for the person taking it, freeing them.

Disadvantages

After knowing all about it, it includes what this process is, how it works, its advantages, and how many types of these loans are. Then, finally, you will ask me why most people do not take it or do not apply for it.

Some of the reasons why people do not consider taking this and the disadvantages of it are below so that you will know both sides of the coin:-

1. It does not mean that the debt is gone:

The biggest disadvantage is that people think that after taking it, there will be no debt for them to clear, but people need to understand that there is a difference between clearing the debt and consolidating debt. 

It does not mean that the debt is gone. The reality is that all of your debt from different sources has been transferred to a single long-term loan, and you have to pay this to eliminate all debt.

It is not like your debt has vanished, but rather than the person being liable to many sources, they will be responsible to only one person or source from where a person has taken the loan.

2. You may have to pay a higher interest rate:

Sometimes when a person takes these types of loans because of his bad credit history and lack of credibility ends up getting a loan with higher interest which is a bigger concern for them.

This is generally happening to people with a credit history and those currently unable to pay their loan due to financial issues, which means there is a higher risk, so the bank charges more interest.

3. End up paying more interest amount:

As we all know, these loans are long-term loans mentioned earlier in this article only, meaning the duration of these loans is mostly 10 to 20 years, which is a lot of time.

It also means that you need to pay them their EMIs regularly with interest, so if you calculate wisely, you will find out that the interest you are giving them is more when it comes to the amount.

The interest you are paying in these types of loans is generally more than the interest you are paying previously, whether the interest rate is less. Still, due to the duration of time, you will end up giving more interest.

4. Collateral requirements:

Some of these loans are secured loans, which means you need to give some collateral before taking this loan. This is a more significant concern because most people do not possess that much collateral to offer as security.

We know that these loans are a huge amount of loans. If we have to show them or give them collateral as a security for taking the loans, most people do not possess that much collateral, which means they will get fewer loans.

It is challenging to get the required amount because of the secured loan policy followed by the bank to make these loans feel secure while giving you the loans.

This results in fewer people taking these loans because they could not satisfy the collateral demand for getting a loan from a bank for the required amount the people want.

We have learned all the essential things that a person needs to know about debt consolidation and its pros and cons to know what is good for you and what is wrong.

So this article concludes that if you are a responsible person and can control or manage your liabilities, you can take this type of loan, or you should not take it.

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Researched and authored by Kartikay Agarwal | Linkedin

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