What is Debt?
Debt is a sum of money that is borrowed by an individual or a firm from another individual or firm and is supposed to be returned back to the debtor on or before a selected date.
Debt Consolidation
Debt consolidation refers to the act of combining all the existing debts into one new single debt preferably at a lower rate of interest, favourable tenure and a lower monthly payment. Here various debts are combined together or are consolidated. Hence it is known as Debt-Consolidation. It’s a kind of debt finance.
The money obtained from the new loan is then used to pay off all the existing loans of the debtor.
Types of Debt Consolidation loans
Mainly Debt Consolidation are of two types:-
A. Secured Loans
Secured loans are those kinds of loans which are generally backed by the assets of the borrower and acts as a mortgage against the loan.
B. Unsecured loans
Unsecured loans are those kinds of loans which are not backed by any assets and normally have a higher interest rates as compared to secured loans.
How does Debt Consolidation Works
When you consolidate your debt’s, you basically combine all your existing debts and convert them into a new debt. This helps you to reduce the interest rate, and also increase the tenure of loan making the monthly payments lower.
To Consolidate your loans you will need to approach your financial institution (Bank/Credit Card agency) and apply for it. If your credit score is good they will give you a feasible Consolidation plan.
If rejected, you can approach Private money lenders or private credit organizations for availing the services of loan consolidation.
Debt consolidation VS Debt settlement:
Debt Consolidation
Means combining your existing debts and converting them into new debt. In this scenario you are not debt-free, instead, you still have a debt to pay off but on favourable tenure, monthly payments and interest
Debt Settlement
Debt settlement is an agreement between the lender and the borrower where the borrower agrees to forego a certain amount of the debt if the lender agrees to do a onetime payment. In this scenario, the borrower is debt-free after paying a lump sum of money as the balance is forgiven by the borrower.
Benefits of loan consolidation
1. Simplifies finance:
Instead of paying monthly payments to pay off several debts at the same time, you have to pay only for one debt which makes it easier for you to track your finances.
2. Reduces your interest rate
This is because you’ve already paid your high-interest rate debts with a new less interest rated debt.
3. Gives you more time
When you consolidate your debt, you get a flexibility of a favourable tenure i.e. you can increase the tenure of your debt, giving you more time to pay off the debt.
Examples of Debt Consolidation
Suppose a person named Harper has 3 different loans with 18%, 20% and 22% interest rate respectively. Let the loan amount be Rs 3,00,000 and loan period be one year for all the three debts. Now every month Harper ends up paying Rs 8,666 as interest along with the monthly payment for the three debts which is a pretty big amount. Also with three different rates, it becomes difficult for Harper to track his finances.
Now if Harper opts for loan consolidation, he has can combine all of the three debts together and convert them to new debt with the favorable interest rate, time period and monthly payment. So instead of paying for three different loans he can just pay for one debt which means he will pay only one monthly payment and on one interest rate.
| Loan Details | 3 different loans | Consolidated Loan |
| Rate | 18%, 20%, 22% | 19% |
| Time period | 1 year (12 months) | 2 years (15 Months) |
| Number of payments per month | 3 | 1 |
| Principal | 3,00,000 (1,00,000 *3) | 3,00,000 |
| Interest | 60,000 | 57000 |
| Total Amount paid | 3,60,000 | 3,57,000 |
Should I consolidate my debt?
Debt consolidation is indeed a very useful technique to reduce some of your debt but is indeed a complex system. You should opt for debt consolidation only if you have the following characteristic.
1. Predictable Monthly Income
That is by the end of the month you earn steady income, enough to pay your debts each month.
2. Good to excellent credit
If your credit score is excellent (i.e. if the banks think that you are capable enough to pat off your debts) only then you will be allowed to consolidate your debts
3. Several high-interest debts
If you have various high-interest rated loans only then you should go for loan consolidation as loan consolidation interest rate is normally higher than a lot of personal loans.
When Loan Consolidation is good?
Loan consolidation is good only if your credit score is excellent and your existing loans have a very high rate of interest with a short time period. Only the loan consolidation will help you to reduce your interest rate and allow you to have a wider time frame.
Alternatives of Debt Consolidation
There are various alternatives of loan consolidation. Some of them are as follows :-
- You can create a strict budget and act accordingly so that by the end of the month you save enough to pay off your debts in time.
- You can get I touch with your debt collector and ask them for any concession if possible. No lender is willing to have a bad debt in his books and hence most of them will help their borrowers in possible ways to recover as much money as they can.
Approach a credit counselor. They will guide you on about how you can clear your debts and live a debt free life.
When is Debt Consolidation bad?
Debt consolidation is bad if your credit rating is not up to the standards of the bank. In such cases a bank will reject your application of loan consolidation as they will feel that you won’t be able to pay back their debt. Also if you don’t have high interest rated debts then debt consolidation won’t make much of a difference as Debt consolidation loans are generally higher interest rated debts than most of the private loans.
Debt Consolidation Loan
Debt consolidation loan is the new loan which is formed by consolidating the existing debts into a new debt to pay them off with a favorable time frame, rate of interest and monthly payments.
Can I get Debt consolidation loan with low credit
Yes you can get a loan consolidation with low credit score. Many private money lenders will provide you with Loan consolidation even if your credit score is not upto the mark, but it is not advisable as you are already in a low credit score and debt consolidation might make it worse for you.
Best Debt Consolidation Loans in India
Few of the Consolidation of debt instruments option are :-
1. Personal Loans By SBI
Various personal loan packages offered by the SBI have a very low interest rate, Concessions to government salaried employees and a wider time frame. Also they provide credit counseling services to their borrowers as well. You can get upto a loan of more than or equal to 10,00,000 with SBI XPRESS CREDIT (Which will come into effect from 10-06-20 as per their official website, sbi.co.in)
2. Personal loans by Bajaj finserv
Bajaj finserv offers a Loan Consolidation option for it’s customers. Through their consolidation loan option a person can get up to 25,00,000 at attractive rates of interest. Also they claim to offer certain other benefits such as : Flexibility, Instant approval , less documentation etc.
Features and benefits of Debt consolidation loan
When you opt for loan consolidation, instead of paying various monthly payments you get the advantage of paying only one payment every month. Loan consolidation also helps to reduce the interest rates by compounding all the interests together into one. It also helps you to increase the time frame of your loan thus making it easier for you to pay off your loans.
Also if you have a average credit score, loan consolidation can help you to increase it. By paying off the principal amount sooner you are able to boost your credit score.
Eligibility Criteria and Documentation for Debt Consolidation Loan
Here are the usual eligibility requirements for a debt consolidation loan :-
- A good credit score: If your credit score is good enough, then you can easily avail the debt consolidation loan.
- A steady income source: if you have a steady income source and are able to pay the monthly installments on time then you are eligible to apply for a debt consolidation loan. This is why normally government. employees get the preference in terms of loans as their income source is steady and reliable.
- Must have all the documentation: To avail the offers of debt consolidation, all the documents related to your existing loans, income , assets etc should he disclosed to the bank as this are vital documents in determining if you are fit to avail the option of debt consolidation.
Debt consolidation without a loan
Yes, Debt consolidation without a loan is possible. There are various credit counselling agencies out there who will provide various loan consolidation plans without typically asking you to take a new loan for consolidation purposes.
Debt to Equity Ratio
Debt to Equity Ratio is a debt instrument that helps us to ascertain whether a business entity has more of debt or more of equity in their finances. It is a very important instrument for measuring the relative proportion of equity and debt.
Debt to Equity ratio formula :-
Total Liabilities
Debt to Equity ratio =____________________
Total Assets
If the Debt to Equity ratio is high, it significantly means that the business entity is not in a position to pay off all the debtors.