Debt Consolidation: How Does it work?
While there are numerous ways to get out of debt, the hardest challenge is facing the problems in front of you. One of the main issues when looking to consolidate debt is that many people leave it too late. However, the process of debt consolidation is relatively straightforward, releasing not only financial pressure but also mental and physical pressure.
What is debt consolidation?
The main financial problem many people face is an array of different debts, payment terms and interest rates. This can lead to numerous monthly minimum payments, which can be challenging to meet as an individual’s financial situation begins to deteriorate. Consolidating debt is simply that, taking out a specialist debt consolidation loan to repay all outstanding debts. This creates a more manageable scenario, with one monthly payment and potentially lower interest rates. There is also the option to extend the term over a more comfortable period to reduce the pressure.
Facing your financial challenges head-on
When looking to get out of debt, the first thing to do is sit down, take a piece of paper and write down your income, expenditure and outstanding debts. In many ways, this is the most challenging stage of debt consolidation, laying out your financial situation in black-and-white. Many people will be surprised and shocked by their financial situation, but once the dust settles, loan consolidation and debt consolidation are, for many people, viable options.
Unfortunately, the longer you leave your financial challenges, the worse they will become, and they will impact your credit rating. This is before we even begin to contemplate both the physical and mental impact this can have on your everyday life. Nobody wants to be in a situation where they dread the next email or letter through the post!
Thinking rationally about debt consolidation
In tandem with considering loan consolidation, it is crucial that you also review your everyday expenses to see where savings can be made. This may mean short-term pain for long-term financial gain and a healthier financial status. However, the likelihood is that if you continue in the same spending vein, you will ultimately arrive at the same challenging situation time and time again in the future.
It can be very easy to look at relatively small savings in isolation without considering the bigger picture. You should be able to secure some savings in areas such as:-
- Food shopping
- Insurance policies
- Social spending
- Utility bills
It is easy to panic, assume the worst, and think things will never get better in this scenario. However, the reality is often very different. A relatively small number of monthly savings in different areas can soon add up. This, together with a debt consolidation plan, allows you to rebase your monthly expenses and begin to look forward to a better future.
Securing loan consolidation finance
There are many issues to take into consideration when looking to consolidate debt, which include:-
Affordable monthly payments
In effect, when looking to consolidate your debts, you need to work backwards to identify the most appropriate terms for any loan consolidation application. For example, there is no point in looking to commit to payments of $200 a month when you know you can only afford $150 a month. Taking an ambitious approach to repayments is admirable, but ultimately it could be your downfall. Be realistic!
Unfortunately, there will be some scenarios where the individual or partners cannot commit to any significant monthly repayments. In this situation, you would need to take further professional advice regarding additional options such as bankruptcy or a creditor repayment plan. There is no point in looking to consolidate debt if you can’t afford the repayments. These additional options are there for a reason; to ensure that you can get out of debt and begin to live again.
Giving yourself some headroom
When putting together a plan to consolidate debt, you must give yourself some “headroom” in the event of unforeseen expenses. For example, if you commit yourself to every free dollar at the end of each month, what happens if your car needs a repair? There are problems with your house?
This then brings us to the next issue, the term of any loan consolidation arrangement. As we touched on above, it is admirable looking to pay off your debt as soon as possible, but you need to be realistic. If you spread the loan repayments over an extended period, this will not only reduce the short-term pressure, but it gives you a degree of flexibility. On the downside, you will pay more in interest in the long term.
Looking ahead, if your monthly income increased, perhaps you found alternative better-paid employment; you may be in a position to make additional repayments. This would bring down the outstanding loan capital and ultimately reduce your interest payments.
Competition in the debt consolidation sector
As the cost of living continues to rise, with wages often failing to keep pace, many people are struggle financially. This has created a vast and highly competitive debt consolidation market. Consequently, it is vital that you scour the market when looking to consolidate debt, ensuring you secure the most competitive terms for your scenario. Thankfully, the Internet now means that you can shop around from the comfort of your own home. No prying eyes or uncomfortable phone calls in the workplace.
The terms and conditions available where individuals look to consolidate debt will vary depending on their financial situation. However, responsible loan consolidation companies will still carry out a credit check to address the risk/reward ratio from their point of view. Assuming you are eligible, the term and the interest rate will reflect your situation.
Stabilise your credit rating
Most people who look towards debt consolidation tend to leave it too late, bury their heads in the sand and hope their financial challenges disappear. Consequently, it is not uncommon to see individual credit ratings in freefall. However, once you have identified your income, expenditure and debts and made plans to consolidate debt, this should stabilise your credit rating.
It is not uncommon for problems with one loan/credit card debt to spiral out of control quickly and compromise other debt repayments. At best, this will lead to late payment penalties and at worst, a debt default — the more penalties and debt defaults that build up, the greater the pressure on your credit rating. Once you consolidate debt under one manageable loan, the penalties will stop, and the threat of default should fade away.
Refinancing in the future
If you are at the stage where you need to consolidate debt, this should be a wake-up call. You may have avoided more severe scenarios such as bankruptcy, but you still need to adjust your attitude to spending. However, if you keep up with your payments, your credit rating will eventually start to recover. At some point, there may be an opportunity to refinance your debt consolidation arrangement on a more preferential interest rate.
Whatever challenges you face when looking to consolidate debt, the main factor is the same for all lenders, the risk/reward ratio. The greater the perceived risk, the high the interest rate on loan consolidation arrangements. Consequently, as your financial situation improves, the risk is reduced, creating a scenario for refinancing.
The physical, mental and financial relief
Even the action of writing down your income, expenses and debts can be highly therapeutic. Yes, you may initially be shocked at the situation, but there are still options available for the majority of people. We all tend to focus on the financial relief of reorganising our debts, but an individual’s and partners’ physical and mental well-being should not be underestimated. The physical impact can be wide-ranging, including:-
- Chest pains
- High blood pressure
- Aches and pains
- Weakened immune system
For many people, the mental impact can be life-changing, taking in issues such as:-
- Mood swings
- Panic attacks
It is very common for these issues to impact your relationship with your nearest and dearest. Many people in this situation will keep things to themselves, struggle to cope and eventually the pressure will become too much. So, if you are in two minds as to whether you need to address your financial problems, make sure you look at the broader picture.
The relief that many people feel when they eventually “get out of debt” can be priceless. But, realistically, the road from near financial collapse to financial recovery can be long and sometimes challenging. There is no silver bullet, no quick fix, and it will take time, effort and perhaps a little short term financial pain to achieve long-term financial gain.
You must address any potential financial issues as soon as possible. Burying your head in the sand won’t help; these issues won’t fix themselves. If ignored, you can guarantee the situation will get worse, at which point your options may be limited. In reality, there are occasions where unexpected expenses can create serious financial problems for individuals and couples. However, in most cases, there will be early signs that things are changing, finances are tighter, and debt repayments are under pressure. That is the time to take action!