What is a Debt Consolidation Loan?

If you have several credit cards and have balances on all of them, for example, you can apply for a loan large enough to pay them all off, leaving you with a single monthly payment. The loan you get typically charges less interest than credit cards, making it easier to pay off.

It's a great concept, but not as simple as it sounds.

Anyone who lends you money to consolidate your debt wants assurances that you'll repay what you borrowed. The consolidation lender will check your credit and may ask for collateral. If you're a homeowner and use a second mortgage or home equity line of credit (HELOC) to consolidate your credit card debt, you could risk losing your home if you can't make the payments.

For this reason, most people take out a personal loan to pay off credit card debt. But a personal loan doesn't work like a credit card. It requires you to follow a strict repayment plan, likely requiring you to pay more each month than the minimum monthly payments you made with credit cards. Again, understand the terms before opting for a personal loan.

How Does a Debt Consolidation Loan Work?

A debt consolidation loan Singapore should have a lower interest rate than credit card debt (sometimes as much as 10%-12% lower), so the amount you spend each month on interest should be reduced. On the other hand, personal loans come with fixed repayment schedules that amortize your debt over several years. For that reason, the cost of your monthly debt payment could easily increase.

If you can afford a higher payment, this can be a good thing. Paying your debts in installments will eliminate your debt instead of postponing it. Minimum monthly credit card payments simply allow the debt to continue to accumulate; a debt consolidation plan signapore will make it disappear, assuming you control your spending and don't accumulate more credit card debt while paying off the loan.

Keeping track of multiple payments to multiple creditors can be difficult. A consolidation loan simplifies the process by converting several bills into a single monthly payment.

It almost seems too good to be true, especially if you get a favorable interest rate, so it's an option worth investigating.

Debt Consolidation Loan Rates

The average interest rate on debt consolidation loan Singapore was 11.88% in the summer of 2020, although rates vary widely, from as low as 6% to as high as 36%. As a general rule, the higher your credit score, the more likely you are to get a low-interest debt consolidation loan.

Conversely, with a credit score in the high 600s, your credit card interest rate could be in the 25%-36% range.

While your credit score is the most important factor in determining the interest rate on your consolidation loan, lenders also look at variables including your income and other debts you may be repaying.

Pros and Cons of Debt Consolidation Loans

Debt consolidation loans can be a lifeline for those who can afford the monthly payments. Although you may spend more of your income on your debt once it's consolidated, a well-structured loan that fits your budget could offer a path to solvency. As with most things, deciding whether to take out a consolidation loan to replace multiple credit card payments has its pros and cons.

Advantages of Debt Consolidation:

A single lump sum: A consolidation loan replaces multiple credit card bills with a single debt, which is repaid over a fixed period of time at a fixed interest rate.

You could save money: If you convert high-interest credit card debt into a consolidation loan with a much lower rate, you'll save money on interest. This is true even if you have a higher monthly payment, since you'll be paying down the principal.The lower the interest rate and the longer the repayment period, the less you'll pay each month.

Simpler finances: If you focus on paying off your consolidation loan, you'll have a single monthly debt payment instead of multiple credit card bills. Even better, your interest rate will be fixed. Credit cards have variable rates, which means the card issuer can raise your interest rate and minimum monthly payment, even if you stop using the card.

Disadvantages of Debt Consolidation:

Higher monthly payments: You'll use the loan funds to pay off your credit cards, but loans have different terms than credit cards. You'll repay your debt over a fixed period, say three to five years, and the payment amount could exceed the combined amount you had to pay to cover the minimum monthly payments on your cards.

Risk of increasing debt: If you struggled to manage your credit and continue to use your credit cards, you could end up with more debt than you originally had. The best strategy is to pay off your credit card balances each month while focusing on paying off your consolidation loan.

Bad credit: If you have a low credit score, one that falls below 620, it may be difficult to obtain a debt consolidation loan. Even if you can find a lender, the interest rate could be higher than what you pay on your credit cards. Before seeking a loan, try to make all your credit card payments on time in an effort to raise your score.