Going into substantial debt is more common than some would think. Generally speaking, most businesses have at least one moment during their lifespan when they are forced to take out multiple loans or lines of credit that need to be repaid monthly. As for regular individuals, overusing credit cards, getting a HELOC or a personal loan can often lead to a large outstanding debt that can become quite expensive over time.
Most are aware of the fact that debt consolidation loans are the best way to make all their outstanding debt more affordable. However, many individuals do not know how to use the money that they get through it. Improperly using a debt consolidation loan can leave one in a delicate situation where one would have to make additional loans and be forced to pay both the debt consolidation loan, as well as the newly created debt. This having been said, what is the best way to use debt consolidation? Before answering this question, it is important to understand what a debt consolidation loan is.
What Is a Debt Consolidation Loan?
Debt consolidation loans are secured or unsecured loans that are designed to help borrowers fuse their existing debt into one. For example, if an individual has a maxed-out credit card, a personal credit (secured or unsecured), and a line of credit, each of these forms of debt will have a different monthly repayment date and separate interest rates. Having to keep track of all of these is often extremely difficult, and the different interest rates can make the overall debt expensive.
A debt consolidation loan is designed to help an individual repay most or all of his current outstanding debt and be left with only this new loan that must be repaid. In other words, he is left with a single form of debt that has one monthly repayment date and one interest rate.
What Are Do’s and Don’ts of Debt Consolidation Loans?
As useful as debt consolidation loans may be, by design, some make the mistake of wasting the money only to find themselves back where they started.
What Borrowers Should Do?
- Determine the Cost of Each Type of Debt – Organising and understanding one’s debt is extremely important. This requires that borrowers determine the exact cost of each type of debt that they have to repay to establish which ones should be covered first;
- Repay the Most Expensive Loans First – Focus on repaying the most expensive types of debt first. Some debt consolidation loans may not be large enough to allow borrowers to consolidate all of their debt. However, they should be enough to cover the loans with the highest interest rates;
- Boost Your Credit Rating before Applying for a Loan – Debt consolidation loans are only useful if they have an interest rate that is lower than the total cost of the debt meant to cover. To ensure that you’ll get a great deal from the lender, it is important to boost your credit score by any means possible. Refrain from taking out payday advances, do not use credit cards at least a few months before applying for a loan and use the many in your savings accounts to lower your credit utilisation ratio;
What Borrowers Should Not Do?
- Do Not Use the Money for Debt That Is Not Urgent – Some debt consolidation loans can also be used to pay for forms of debt that are not created through loans or lines of credit, such as home renovation bills;
- Do Not Ignore Variable-interest Debt – Some borrowers tend to consolidate expensive high-interest loans and leave variable-interest ones hoping that they will become cheaper in the future. In reality, these are the first ones that should be repaid as they make it nearly impossible to set up repayment budgets and to balance one’s income and expenses;
- Do Not Consolidate Debt If It Is Not Needed – Debt consolidation loans are often long-term loans and should only be used if the existing debt is too expensive. Generally speaking, these loans are not taken lightly by lenders and will lower an individual’s credit score considerably, essentially decreasing the probability that he will be able to take out other loans in the near future;