Have you ever faced a situation where you have to simultaneously pay back your credit card bills, an EMI on your car loan, and another EMI for your house every month? If you have, you should consider the debt consolidation strategy, which can simplify your life.
"How?” you ask! To begin with, first let us understand what is a consolidation loan. Let us look in detail at what is debt consolidation-the meaning, benefits and tips on how to do it.
What is a debt consolidation loan?
A debt consolidation loan means essentially a process of combining multiple financial obligations like credit card balances, outstanding loans, and other debts, into a single Personal Loan. It may offer lower interest rates and a longer repayment period than some of your existing debt. This restructuring can result in a single, more manageable monthly payment.
How does debt consolidation work?
Debt consolidation is a process that involves combining multiple outstanding loans into a single loan or credit line. Here's a breakdown of consolidation debt definition and how this process operates:
- Start by assessing your existing debts. This includes studying your Credit Card balances, Personal Loans, or other types of financial obligations. List the total owed amount, interest rates charged on each loan, and monthly repayment obligations.
- Research about various debt consolidation options available to you. Common methods include Personal Loans, Balance Transfer Credit Cards, Home Equity loans also known as Top-up Home Loan or lines of credit.
- Select the consolidation method that aligns with your needs and financial situation. Consider factors such as interest rates, fees, repayment terms, and any associated risks for each option.
- Once you have determined the most suitable consolidation strategy, apply for a loan or Credit Card that facilitates consolidation.
- Once your application is approved, you will receive the consolidation loan or Credit Card funds. Use this money to pay off your debts, effectively merging them into a consolidated debt obligation.
- Following the consolidation of your debts, you will be responsible for making a single payment every month on the new loan or credit line by the terms and conditions outlined in the consolidation agreement.
Also Read: How Does a Personal Loan Help in Debt Consolidation?
Consolidation loan meaning with examples
If you find yourself dealing with multiple Credit Card loans, each with different interest rates and minimum payments, a debt consolidation loan can simplify your financial situation by allowing you to pay off those cards. This leaves you with just one manageable monthly payment instead of juggling between multiple payments.
Consider the following scenario where you're tackling Credit Card debt:
Card 1: Rs 50,000 balance with a 20% interest
Card 2: Rs 20,000 balance with a 25% interest
Card 3: Rs 10,000 balance with a 16% interest
If you were to pay off these Credit Card balances over 12 months, your total interest costs would amount to Rs 9270. However, let us say you opt for a 12-month personal loan for the total amount you owe, which is Rs 80,000, with a 10% interest rate. By paying off this loan within a year, you significantly reduce your interest expenses to just Rs 4,400.
Benefits of debt consolidation loan
Here are the top three reasons why you should consider debt consolidation:
1. Streamlined management
As we saw in the example above, debt consolidation makes managing your finances so much easier. With this strategy, it is unlikely that you will miss out on paying any of your monthly EMIs.
2. Reduced monthly payments
As per the example, you can see that the total EMI per month is reduced to half. The key is negotiating the interest rates and extending your repayment terms to enjoy lower monthly payments. This flexibility provides more financial breathing room to tackle your debt.
3. Enhanced credit score
You can strengthen your overall creditworthiness by achieving a better balance between instalments and revolving debt and establishing a positive track record of on-time payments.
How to apply for a debt consolidation loan?
You can apply for a new Personal Loan from Axis Bank to achieve a lower combined interest rate. Use this loan to settle your Credit Card debt and other high-interest loans. Ensure that the new loan comes with favourable terms and conditions.
Axis Bank's 24x7 Personal Loan streamlines the application and disbursement process, offering a fully online experience with minimal documentation for new customers. Existing Axis Bank clients can benefit from instant disbursement with zero documentation, while new customers can enjoy 100% digital process or minimal upload of documents.
Also Read: Should you take out a personal loan to pay off credit card debt?
Meaning of consolidation of debt and its impact on credit scores
Here's how debt consolidation can influence your credit score:
- New credit applications
Lenders will conduct a hard inquiry when you apply for a Personal Loan or a Balance Transfer Credit Card as part of your debt consolidation plan. This can lead to a slight decrease in your credit scores. This decrease can occur before you've begun the debt consolidation process.
- Lower credit age
Your credit score tends to improve as your credit accounts age and showcase a positive history of on-time payments. However, opening a new account can reduce your account's average age, lowering your credit score.
- Lower credit utilisation ratio
Credit utilisation measures the percentage of your total available credit that you use. When you establish a new debt consolidation account, your available credit typically increases, potentially decreasing your credit utilisation ratio. Lower credit utilisation can offset some of the adverse effects of opening a new account.
- Enhanced payment history
While it may take some time, consistently making on-time payments on your new loan will gradually boost your credit scores. Your payment history significantly influences your credit scores, highlighting the importance of always meeting payment deadlines.
Debt consolidation vs debt settlement
Debt consolidation involves taking a personal loan to merge multiple unsecured debts into one. Once approved, the lender provides you with an amount to settle your debts, often paying your creditors directly. As a result, you're left with a single fixed monthly payment featuring a steady interest rate.
On the other hand, debt settlement, also known as debt relief, involves negotiating with your creditors to persuade them to forgive a portion of your debt. You can handle this process independently or assign a debt settlement company to negotiate on your behalf.
Debt consolidation is preferable for some individuals as it offers a streamlined path to debt-free. However, it requires a good credit to secure favourable loan terms and the capability to meet regular payments. If you are burdened by an overwhelming amount of debt or anticipate difficulty paying it off independently, debt settlement becomes a viable option.
Conclusion
Consolidating your Credit Card debts can be a beneficial solution if you grapple with multiple Credit Card obligations. It simplifies the repayment process by amalgamating various payments into a single one. However, you must consider factors like associated costs, repayment terms, and the potential impact on your credit score.
To check if debt consolidation aligns with your unique financial circumstances, you must do thorough research and, if necessary, seek professional guidance.
Disclaimer: This article is for information purpose only. The views expressed in this article are personal and do not necessarily constitute the views of Axis Bank Ltd. and its employees. Axis Bank Ltd. and/or the author shall not be responsible for any direct / indirect loss or liability incurred by the reader for taking any financial decisions based on the contents and information. Please consult your financial advisor before making any financial decision.
