The purpose behind obtaining a debt consolidation loan is to merge multiple debts into one single payment. The advantages and disadvantages of a debt consolidation depend on the purpose of the consolidation, and the type of loan. A debt consolidation loan can cost you huge if you stretch out payments, or can be fruitful to you if you consolidate the debt onto one lower interest rate.
Types
Debt consolidation loans can be of many shapes. Some private companies and the federal government provide special consolidation loans to students to consolidate student loans under special conditions.
People may also choose a debt consolidation loan to consolidate their credit card debts. You can consolidate your credit card debts by using credit card balance transfers, personal loans and home equity lines of credit.
Advantages & Disadvantages
The advantages & disadvantages of debt consolidation depend on the type of consolidation loan borrowed. If you are approaching a balance transfer on a credit card to consolidate your debt, you can save money on interest. However, you have to do that before the promotional offer (0% interest balance transfer) ends. You can also reduce the interest rate by taking out a personal loan, but fees may be associated with this as well. However, the interest rates of personal loans are usually higher than the credit card balance transfer rates.
Lastly, you can also opt out a home line of credit or second mortgage to consolidate your debt. This is always a risky move as here you are transferring your unsecured debts into a secured debt- keeping your home at stake if you cannot pay back the loan.
Consolidating Debt and Your Credit Score
If you consolidate your debts, it may lower your credit score. 30% of your FICO score is determined by how much you owe. Your debt-to-credit ratio is a significant issue in determining this component of your FICO score. The credit score gets lower if you use more of your available credit. If you are taking out a consolidation loan and make use of the full line of credit, it can negatively affect your debt-to-credit ratio. Therefore, though you can save money in interest, yet if you take out a large loan within two years, you should ponder on if the lower credit score would be worth the interest you save.