What is a Debt Consolidation Loan and How Does it Work?

Being in debt can feel like a huge burden.

Many people don’t feel like they have options, or know where to turn.

As many people fall behind with payments, the debt grows, and it gets harder and harder to pay off.

However, there’s always a suitable solution for you and your unique situation.

Debt consolidation is one particular solution that could be applied if you have numerous debts and want to find an easier, less stressful way to pay them off.

Having several debt payments to be paid at different times throughout the month can feel cumbersome, and in some cases you may even forget or struggle with cash flow as a result.

However, debt consolidation makes paying these debts so much easier.

Learn more about this solution below and find out whether it’s the right thing for you to do.

What Is A Debt Consolidation Loan?

A debt consolidation loan is where you approach a bank, credit union or finance company and they provide you with the money to pay off your outstanding credit card debts and other kinds of debt.

This combines all of the debts together into one payment, ‘consolidates’ them, making it easier for you to pay off.

A debt consolidation loan simply means paying off your existing loans with another loan and then paying the balance off that one loan.

This can make your finances easier to manage and less stressful, while also making it easier for you to put together a budget and manage monthly cash flow.

A debt consolidation loan could be useful if you are having trouble making the minimum monthly payments towards your debts because you forget when they are due or struggle to manage cash flow.

There are both pros and cons to having your debts consolidated into one payment like this, though, so you need to explore each one first before making up your mind.

How Does A Debt Consolidation Loan Work?

You will approach a debt consolidation lender and once you are accepted for the loan, they will loan you money to pay off your existing debts.

You will then pay off your existing debts with the money you are loaned and close the accounts.

It is your job to then make just one payment for the entirety of the debt to the lender.

This is not a good idea for those who have poor spending habits and could end up taking out new credit cards after a short while – you may end up doubling or tripling your debt rather than paying it off and getting a fresh start.

Can you trust yourself with money and stop yourself from spending unnecessarily?

If you know your spending is triggered by something, it could be worth getting the root of the problem before going ahead with a consolidation loan.

If you truly want a fresh start and you know that you will find it easier to pay off all of your debts with one simple payment each month, this could be the right choice for you.

What Are The Advantages Of A Debt Consolidation Loan?

There are advantages to a debt consolidation loan that make it an attractive option for those who have numerous debts to pay each month.

Your current debt will be paid off almost immediately when you are accepted for the loan, so it may instantly feel like a weight has been lifted from your shoulders.

Your loans will not actually be paid off, though, as it will now be your responsibility to pay the debt consolidation loan.

It will, however, take the pressure off compared to when you are having to make many different payments each month.

You should also be able to consolidate at a lower interest rate, saving you money over time.

This may not always be the case, as it’ll depend on the term of the loan, but you could save money in the long run if you choose to pay off the loan as quickly as you can.

You’ll also know that your debt will be paid off in a specific amount of time providing you keep on paying – usually 2-5 years.

When you have credit cards you may commit to paying them off at first, only to feel tempted to use them again after a short while.

This can leave you feeling like you are always in debt, and some even take out more credit cards when they have maxed out their current cards.

As you close the accounts when taking out a debt consolidation loan, you should not be tempted to spend any more.

It’s also worth noting that if you borrow money from a bank or credit union, then there usually aren’t any fees.

A fixed payment ensures that you know exactly what you’re paying each month, so that figuring out your budget will be so much easier as you’ll have a much clearer idea of the amount that will be debited and exactly when it will leave your account.

It’s fairly easy to reduce your monthly payments by spreading the loan over a longer period of time, too (just be aware that you will pay more interest over time if you choose to do this).

What Are The Disadvantages Of A Debt Consolidation Loan?

A debt consolidation loan could be the perfect solution for many, but it isn’t necessarily the right one for you – there are some disadvantages you’ll need to carefully consider before going ahead with it.

You may struggle to find a debt consolidation loan you’ll be accepted for depending on the amount and your credit rating, so this isn’t a guaranteed solution for everybody.

If you are rejected and then apply for another loan, this could affect your score in a negative way too.

Applying for many debt consolidation loans in a row does not look good for your credit and could further harm you in the long run.

If your income is erratic and you’re not 100% certain you will be able to keep up with the payments each month, it’s probably best you avoid this kind of loan.

A debt consolidation solution is really only for those who A) want to make their finances simpler and B) know for certain that they will be able to pay the amount each month.

Those who are having real debt troubles or find themselves continuously falling into arrears will find that a debt management plan or solution may be the better option for at this time.

A debt consolidation loan may simply be another debt if you feel powerless to stop yourself taking out lines of credit again soon after.

Unsecured Vs. Secured Loans

There are two types of debt consolidation loan that you should be aware of before going ahead: unsecured and secured.

Your lender will decide the terms and the interest rate after they investigate your credit score.

If you have bad credit they may offer you a loan but it will be secured against your car or house.

This means that if you miss payments, you run the risk of having your secured property taken away from you as payment instead.

About Debt Consolidation Loan Interest Rates

Every debt consolidation loan will differ depending on circumstances, and therefore, so will the interest rates.

The interest rates on your consolidation loan could potentially help you to save a lot of money in lost interest.

However, you must remember that if you decide to pay the total amount off over a longer amount of time, you will end up paying more interest.

It may look like a lower payment initially, but if you figure out the numbers then you may see that you are actually paying off more over time.

For some, this may not be a problem if it helps cash flow and gives peace of mind, but others may prefer to go for a different solution or to pay the loan off over a shorter time period.

It’s always worth doing the math yourself and being honest about what you can afford and what you want your cash flow to look like over the next few years.

Get In Touch With Bankruptcy Canada

If you feel like your debts are getting on top of you and you don’t know what to do, get in touch with Bankruptcy Canada today.

We can help to advise you based on your personal circumstances and you will see that there is a solution out there for you.

We are Canada’s debt experts and we have helped thousands of people just like you to get out of debt for over 20 years.

If you’re looking for a fresh financial beginning, our professional team can help you on your way.