Understanding the Functioning of Consolidated Loans

Understanding the Functioning of Consolidated Loans

The term debt consolidation defines the process in which multiple debts are combined into a single payment. Depending on the type of loan and the purpose of the consolidation, there are benefits and disadvantages that can be associated with the consolidation of debts. For instance, consolidation can end up costing people more money over the life of the loan if they choose to stretch out the payments, but will cost considerably less if they are able to consolidate their debt at a low interest rate. Understanding the function of consolidated loans is essential to people when they are considering this option.

Understanding the Functioning of Consolidated Loans Understanding the Functioning of Consolidated Loans

Types

There are many forms of debt consolidation loans. Private companies are willing to offer people special consolidation loans and even the federal government gives this option to students for consolidating their student loans under particular circumstances. Typically, in these student loan consolidations, the time period of the loan is stretched while the amount remains the same. This can lead to reduced monthly payments, but will eventually cost more. There are also other benefits of student loan consolidation, which include lowered interest rates, repayment incentives and even debt forgiveness in some cases. Another option that can prove to be useful for people is credit card consolidation. Home equity lines of credit, personal loans and credit card balance transfers can be used for consolidating credit card loans.

Benefits

As there are different types of consolidated loans that can be found, their benefits also vary accordingly. It is possible for people to save money on interest when they opt for a balance transfer on a credit card, which means that balances are transferred to one card that offers the lowest possible interest rates so debt is consolidated in this way. However, a fee is also charged for these balance transfers. In addition, failure to make timely payments can lead to an increase in interest rate.

The interest rate can also be lowered by people if they choose to take a personal loan for paying off their credit card bills. But, the interest rate of personal loans is usually higher than that of balance transfers. A second mortgage or home equity line of credit can also be taken by people. However, this can put your home at risk, which is why most people don’t like to choose this option.

Credit Score

Initially, the credit score of individuals will take a dive when they decide to consolidate their debts. This is because 30% of the FICO score is decided by what’s owed by people and the debt to credit ratio can have a substantial impact on the FICO score. Thus, your debt to credit ratio will be adversely affected when a consolidated loan is taken out by using the full line of credit. In addition, when individuals apply for a new loan, their average age of credit will be further reduced. People have to decide if the lowered interest rates of consolidated loans are worth the reduction in credit rating and then take a decision accordingly.

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