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How Does Debt Consolidation Work?

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Debt consolidation refers to combining multiple small loans, debts, and bill payments that you owe. After consolidating all debts and repaying them, you will be responsible for making a payment towards one loan only. Consolidation of debt does not reduce your debt; it just makes loan repayment more manageable. 

How Does It Work?

You may think that simple loans are combined into virtually impossible ones in this scheme. But, every loan has different terms and conditions, interest rates, and the repayment period. It is more likely the loans are borrowed from different lenders. And this is a significant hurdle in combining them. 

 

  • Calculate How Much You Owe

 

The first step in debt consolidation is calculating how much you owe actually. Besides loans, you can also add credit card outstanding balances to the final consolidated amount. The basic idea behind this is to make sure you have only one monthly payment after consolidating loans.

 

  • Apply for a Fixed-Rate Loan

 

 In this debt management method, you take a significant amount of loan (with a lower interest rate) enough to repay other debts. Once all other debts are repaid, you will have one monthly repayment of the personal loan. While taking a personal loan to pay off other debts, make sure you can afford the monthly repayment. 

 

  • Use the New Loan to Repay Other Debts 

 

After your loan is approved, you need to use the money to repay your old debts only. Make sure you do not use the funds elsewhere else the whole process to become debt-free will backfire. 

 

  • Make Timely Payments Towards New Loan

 

To achieve the objective of becoming debt-free, you eventually need to make a timely payment towards your loan. Make sure you do not miss payments though it has lower interest rates. This will balloon your debt amount and make repayment harder. 

 

Benefits of Debt Management Loans

  • It allows you to leverage lower interest rates. With this method, you can switch from multiple high-interest loans to one lower-rate loan.
  • Making various payments is confusing. Debt management loans allow you to streamline the process of debt repayment in an organized manner. With only monthly repayment to make, you can clear the confusion and take control of your financial situation. 
  • Having an easily manageable payment can help improve your credit score. When you repay all your debts and make timely payments towards your debt management loan, the credit score improves.
  • Having a single monthly payment allows you to budget more easily.

Things to Remember While Taking Debt Management Loans

  • When taking a loan to repay other loans, make sure the interest rate is lower than your current loans. 
  • Do not go for extended repayment periods as you end up paying more. 
  • Prepare a budget and find out the maximum amount you can afford as repayment.
  • In some cases, you have to pay hidden fees or extra fees to clear your old debts in this way.

Debt consolidation is a popular way to manage debts and make repayment easier. The ultimate objective is to repay your debt quickly and improve your financial condition. 

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