Loan consolidation is the process wherein a borrower takes a large loan to pay off his smaller loans. This helps bring together all outstanding dues either to credit card companies or banks and other lenders under one roof. In effect, instead of paying different EMIs, the borrower has to pay only one EMI.
What is the Need for Loan Consolidation?
The need arises when the stress of handling too many loans becomes overwhelming.
- Avoids need to keep track of multiple dates for EMI payouts.
- It is safe to have one loan, one date payout if credit is staggered.
- Allows you to ensure your credit history is good if repayment is on time.
- Sometimes, money is saved since the rate of interest offered in loan consolidation is lesser than the interest charged on original loans.
Types of Borrowings for Loan Consolidation
- Secured consolidation loan
- Unsecured consolidation loan
- Secured Consolidation Loan
When you opt for a secured consolidation loan, the lender demands collateral. This could be your house or any fixed asset. A secured consolidated loan demands a borrower to surrender the right of the asset he or she gives as collateral till the loan is cleared. In case of failure to repay, the lender reserves the right to sell the pledged property to recover his dues.
- Pledging an asset is mandatory.
- Lenders give secured loans to incentivize the borrower to pay on time.
- Unsecured Consolidation Loan
While giving an unsecured consolidation loan, the pledging of an asset as the guarantee is not mandatory. Such loans are also known as ‘signature loans’ since it is just the signatures of the borrower and lender which guarantees the loan. A borrower must have a good credit history and should be in a strong financial position to be eligible for an unsecured consolidation loan.
- There is no need to give collateral.
- Loan approval is based on the borrower’s credit history.
- Also known as ‘Signature Loan’.
Advantages of Loan Consolidation
Borrowers see numerous pros in opting for loan consolidation. There are options that offer lower interest rates than existing loans. In addition, borrowers can extend the tenure of the loan making their financial health more manageable.
- Low-Interest Rates
Borrowers get the choice to repay their multiple loans as one consolidated loan with a reduced rate of interest.
- Increase Loan Term
The borrower gets an option to extend his loan tenure. In other words, if a person has five years to pay off his loans currently, with loan consolidation he gets a breather to take another year or so to pay his dues.
- Monthly Savings
With lower interest rates and an increase in tenure, the borrower gets some extra cash for his monthly expenses.
Disadvantages of Loan Consolidation
Loan consolidation comes with some caveats. It has some disadvantages which the borrower must keep in mind before opting for it.
- If the borrower has taken a secured loan to consolidate his existing loans, he or she risks losing an asset pledged in case of failure of repayment of the loan.
- Lower interest rates may initially look attractive. But in the long run, a borrower may end up paying more since a reduced interest comes with a longer repayment term.
- Lenders demand a higher processing fee and a one-time fee from borrowers who opt for loan consolidation.
In conclusion, while loan consolidation has its advantages, it works better for people who are prepared to choose a loan which offers a long term repayment plan. More importantly, it helps borrowers who have the discipline to fix their spending behavior. Loan consolidation works very well for people who make the effort to save the extra money which they have in their pocket due to lower interest rates.