What is a Consolidation Loan?

Consolidation loans are offered by banks and independent lending institutions and are often taken out in an effort to gain control over finances.

Put simply, debt consolidation involves turning multiple loans into one large loan – i.e. taking out one large loan to pay off all existing debt (clothing accounts, credit cards and car loans for example) and making one monthly repayment instead of many.

Consolidation loans have their own set of advantages and disadvantages and as with most things, knowledge is the key. Here’s what you need to know:

Firstly, let’s cover the difference between a secured and an unsecured loan.

A secured loan is taken out against an asset, usually property. For this reason, prospective lenders will qualify for a larger loan and a lower interest rate. This is because the loan is secured against the asset and should the lender default on his/her payments the bank can sell the asset to recover the money that’s owed.

An unsecured loan doesn’t involve any collateral and is generally approved for smaller amounts and comes with higher interest rates. However, in the event that lenders fail to make payments, the upside is that they don’t stand to lose their home.

The reason this is being covered is because one of the most common ways to consolidate debt is by drawing money from an access bond. Home loans generally have lower interest rates than other types of loans, depending on repayment period (10, 20, 30 years) and credit history.Money is drawn from bond and used to pay off existing smaller debts. This allows you to make one monthly payment at a lower interest rate instead of paying back multiple lenders at different interest rates. Keep in mind that more money will now be owed on the bond.

The danger with this is that individuals taking out a loan of this type sometimes fall into the trap of making the minimum payment every month and end up paying back a lot more money in the long run and you need to be wary of this. Another danger is that in the event that the debtor defaults on payments, the bank is in the position to sell their property.

Another option is comes in the form of credit card balance transfers. This involves transferring multiple credit card balances to one card. There is usually a balance transfer period, where little or no interest is payable. This allows you to take advantage of this and recognize savings during this period. However, once the interest free period expires, the normal (high) credit card interest rate resumes.

Standard personal loans are another method of debt consolidation. Amounts and interest rates will vary between the different banks and lending institutions. Personal loans will normally be unsecured (and therefore have higher interest rates) and you should take the time to shop around and find the best deal.

The most important thing to remember when it comes to any loan is to try and pay it off as fast as possible.