How Do Debt Consolidation Loans Work?

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Every day millions of people from all over the world reached the point of no return in regard to personal debt. One of the biggest mistakes people in debt make is doing nothing about it. A lot of people think nothing can be done.

Debt consolidation is a debt management strategy that combines existing debts into a single loan, called a consolidation loan. Many debtors secure consolidation loans from banks or credit unions. Most consolidation loans have a fixed term, generally 3 to 5 years. While consolidation loans have significant advantages, you should note that new debts that you incur after securing your consolidation loan will not be paid off by your consolidation loan.

A big decision

For many, the decision to secure a consolidation loan is more difficult than securing the loan itself. You have to ask yourself why you should consolidate your debts.

There are many reasons to consolidate debts. However, let’s outline the more significant. Generally a consolidation loan will lower your total APR or annual percentage rate. Most consolidation loans have fixed APRs. Consolidation loans offer discipline for many debtors because they only have to pay one bill.

Do the math

Securing a debt consolidation loan only makes sense if your new APR will be lower than your existing ones. You should never take a debt consolidation loan with APR that’s higher than the average APR you’re currently paying.

The average of your existing loans is rather easy to determine. For example, let’s say 5 existing debts, with APRs on each of 12, 15, 14, 16 and 18 percent. The total of these works out to 75 percent. Divide that by the number of percentage rates, five, and you get 15 percent. This is the average APR on existing loans.

Now as you shop for consolidation loans through various lenders, you have a baseline in which to work off of. A consolidation loan with a 13 percent APR would serve to your advantage, while one at 16 percent would not.

Hope for those with bad credit

It’s likely that your credit report is not what it once was. That said, some lenders take it into account that your monthly payment will be reduced, and accomodations for bad credit would also be accounted for.

Figuring out where you are in your debt situation is crucial to getting a plan together to get out of it. Consolidation loans work for a lot of people. They do not work for everyone.

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