What is Debt Consolidation? Is it a good option?

Summary

When a person has multiple debts – such as personal loan, credit card bill, car loan etc. – and he gets tired of paying EMIs of all the debts on different dates, then Debt Consolidation can be a wise option. It means combining all these debts in a single loan and paying it in just one EMI.

The biggest advantage of this is that now you have to pay only one EMI every month, which reduces mental stress and makes budget planning easier. Also, if the new loan is available at a lower interest rate, then there can be savings in the total interest as well.

The second big advantage of Debt Consolidation is that it can improve your credit score, provided you keep paying the EMIs on time. Having a single EMI also reduces the chances of missing a payment.

However, it also has some disadvantages. If you take a new loan for a longer period, then you may have to pay more interest. Also, some institutions charge processing fees, pre-payment charges etc. And if you do not control your expenses, you may end up in debt again.

Introduction

In today’s time, many people use more than one loan or credit card. Some have personal loans, some have home loans, car loans and on top of that, credit card liabilities. In such a situation, when installments (EMI) have to be paid at different places every month, not only the burden of money increases but mental stress also starts. In such a situation, an option comes up which is called – Debt Consolidation i.e. “integration of loans”.

Debt Consolidation simply means taking a new loan by combining all your small and big loans so that instead of paying several installments every month, you have to pay only one EMI. For example, suppose you have bills for 3 different credit cards and also a personal loan. Now, you take a new loan and repay all those outstanding amounts, and after that, you have to pay the EMI of that new loan only. This not only improves your monthly budget but can also reduce the interest rate if the right plan is chosen.

Debt Consolidation can prove to be especially beneficial for those who are unable to track the payment of their loans or are paying fines due to repeated late payments. Through this, you can give a new direction to your financial situation, provided you adopt it wisely.

In today’s article, we will know in detail what the advantages and disadvantages of Debt Consolidation are, what can be done, and what things should be kept in mind so that this option proves right for you. If you are also troubled by the burden of loans and are looking for a solution, then this article can prove to be very helpful for you.

What is Debt Consolidation?

Debt Consolidation means taking a single new loan by combining several small and big loans so that you have to pay only one EMI every month instead of several different installments. Suppose you have a personal loan, credit card dues, and some other loans. To repay all these, you take a new loan, by which all the old loans are repaid. Now, you only have to pay the EMI of that new loan. This makes your financial planning easier, and your money management also improves.

The main advantage of debt consolidation is that it can reduce the interest rate, and you do not have the tension of multiple payments. Just one loan EMI has to be paid on time. This method proves beneficial for those who are paying more than one loan and are not able to manage them on time.

How does debt consolidation work?

Debt Consolidation is a method by which you take a new loan to repay all your old debts by combining them. This process works in a few easy steps:

First, make a list of all your debts

Gather information about how many debts you have – such as credit card bills, personal loans, education loans, etc. It is also very important to know the outstanding amount, interest rate and EMI of each loan.

Apply for a Debt Consolidation Loan

Now you apply for a Debt Consolidation Loan from a bank, NBFC (Non-Banking Financial Company), or online platform. This institution gives you a big loan so that you can repay all your old debts.

Repayment of old debts

After getting a debt consolidation loan, you immediately repay all your old debts, such as credit card dues, personal loans, or other loans. N, ow all these debts are over.

Pay only one EMI

Now every month you have to pay EMI of only that new loan which you took for Debt Consolidation. This saves you from the hassle of multiple loans and different dates.

Pay attention to interest rates and tenure.

Debt Consolidation loan is usually like a personal loan, and the interest rate in it can be low or high. So you have to decide whether your total interest will be low or high.

Let us understand with an example

Suppose you have three loans:

• Credit card dues: ₹50,000 @ 36% p.a.
• Personal loan: ₹1,00,000 @ 15%
• Education loan: ₹75,000 @ 12%

The EMIs of all these get paid on different dates, and your mind also remains troubled. You now take a fresh Debt Consolidation Loan of ₹2,25,000 @ 11% interest. All the old debts are repaid, and now you have to pay just one EMI – that too at a lower interest rate.

What things should be kept in mind while doing Debt Consolidation?

If you take this step without thinking, then instead of benefiting, it can cause loss. Therefore, keep the following points in mind:

Compare the interest rate

• While taking a debt consolidation loan, see if the new loan is available at a cheaper interest rate than the old loan.

• If the new loan is cheaper, only then will it be beneficial.

• If the interest rate is high, then the total payment may increase.

Pay attention to the loan tenure

• Often, people increase the loan tenure in the greed of low EMI.

• With a longer tenure, the EMI is less, but the total interest has to be paid more.

• So maintain a balance – neither too long a period, nor too short.

Loan-taking institutions should be reliable

• Always take a debt consolidation loan from a trusted bank or NBFC.

• Do not take loans from unknown websites or unknown apps online – these can be frauds.

Repay old debts on time

• Debt consolidation means repaying old debts.

• As soon as you get a new loan, repay all your old debts immediately, otherwise, you will have to take a double loan.

Check hidden charges

• There may be processing fees, pre-payment charges, documentation fees, etc., in the new loan.

• Take a clear account of all the charges; otherwise, your budget may get messed up later.

What are the advantages (pros) and disadvantages (cons) of doing Debt Consolidation?

This method can be beneficial, but it also has some disadvantages.

Advantages (Pros) of Debt Consolidation

• Now, you do not have to pay multiple EMIs every month.

• Just one EMI saves both money and time.

• The tension and confusion of paying multiple loans at once ends.

• The mind remains calm, and financial planning becomes easy.

• If the interest rate on the debt consolidation loan is lower than the old loans, then your total interest expense can be reduced.

• If you pay the EMI of the Consolidation loan on time, then it improves your CIBIL score.

• Having only one EMI makes it easier to plan monthly expenses.

• When you focus on the fixed EMI, gradually discipline with money increases.

Disadvantages (Cons) of Debt Consolidation

• If you increase the loan period, the EMI may be reduced, but the total interest has to be paid more.

• There may be hidden charges like processing fees, foreclosure charges, penal interest, etc.

• Many times, people think that the old debts are over, and now a new loan can be taken again.

• Debt Consolidation gives you relief, but if you do not control your expenses, then it can also be useless.

• If you take a Debt Consolidation loan and delay in paying its EMI, then it can harm your credit score even more.

Note: If you do not want to use the Debt Snowball Method to finish your debt, then you can also use the process of Loan Settlement. Let’s know about Loan Settlement in detail.

What is a Loan Settlement?

Loan Settlement is a process in which you negotiate with your creditor to forgive a part of the outstanding amount on your Loan by making a lump sum payment. It is an agreement that you make with your card issuer as a last resort when you see that your Loan debt is increasing.

This can happen due to many reasons, ranging from unnecessary spending to careless spending habits. When your debt increases, the interest on it also increases, which can make it difficult for you to repay the outstanding amount. If you do not see any way out of this, then you can recommend a Loan Settlement.

What documents are required to do a Loan Settlement?

Let us know what documents are required for a Loan Settlement.

1. ID Proof

• Aadhar Card
• PAN Card
• Passport
• Driving License
• Voter ID

2. Address Proof

• Aadhar Card (if it has the correct address)
• Electricity or Water Bill
• Copy of Bank Passbook or Bank Statement
• Rent Agreement (if you live on rent)

3. Income Proof (if required)

• Salary Slip (if you are employed)
• Bank Statement (last 6 months)
• Copy of Income Tax Return (ITR)
• Business Documents (if you are a businessman)

4. Loan Statement

You will have to provide the Loan statement to give the correct information about your outstanding balance. The bank can also generate this statement itself, but sometimes they ask you for a copy of it.

5. Settlement Request Letter

If you are approaching the bank for settlement on your own, you will have to give a written Settlement Request Letter in which you can explain:

• Why do you want a settlement?
• What is your financial situation?
• How much can you pay as a one-time payment?

6. Settlement Offer Letter given by the bank

When the bank agrees to the settlement, they give you a Settlement Offer Letter. Read it carefully and confirm the amount and terms mentioned in it.

What to do before doing a Loan Settlement?

Below are some steps that should be followed before a Loan Settlement:

• First of all, check your income, expenses, and all other debts properly. Know how much you can repay.

• Before a Loan Settlement, share your problem with the bank or lender. 

• Sometimes, they can offer you a better solution, such as reducing the EMI or increasing the loan term.

• Contact a financial advisor or expert. They can help you make the right decision and explain how a Loan Settlement will affect your credit score.

• If you decide to do a Loan Settlement, read the terms and conditions given by the bank carefully. Make sure that you are not being charged any hidden fees.

• Doing a Loan Settlement can reduce your credit score. This can make it difficult to get a loan in the future. Make a decision keeping this in mind.

• Loan Settlement should be the last option. Before that, consider other options like refinancing, reducing EMIs, or asking family and friends for help.

What are the reasons for doing a Loan Settlement?

Below are some common reasons:

• If a person loses his job, stops a source of income, or suffers huge losses in business, then it may be difficult to repay the loan on time.

• There may be a shortage of money to repay the loan if the expenses suddenly increase due to a major illness or medical emergency.

• Many times, a person has the burden of more than one loan, which becomes difficult to repay on time.

• There may be problems in repaying the loan due to any natural disaster, accident, or any major crisis in the family.

• If the interest rate of the loan is very high and there is a problem in repaying the installment, then a Loan Settlement is resorted to.

• Many times, a person is not able to manage his expenses and income properly after taking a loan, which causes problems in repaying.

How to apply for Loan Settlement?

If you are unable to pay your Loan dues and are troubled by heavy interest rates, a Loan Settlement can be a possible solution. Under this process, the bank or Loan company can waive off part of your total outstanding amount and give you the option to make a lump sum payment (One-time Settlement). However, this can affect your CIBIL score, so adopt it only as a last option.

Step-by-step process to apply for Loan Settlement

• First of all, decide that you are not in a position to pay the entire Loan dues.

• Check your income and expenses and decide how much you can pay at the most.

• Talk to the customer care of your bank or Loan company and tell them about your current financial situation.

• Ask for a settlement offer from the bank and start the conversation.

• The bank will propose a settlement amount, which will be lower than your outstanding amount.

• If you don’t accept this amount, negotiate with the bank and attempt to lower the amount based on your capacity to pay.

• After the bank and you reach an agreement on a specific amount, ensure that you receive a written settlement letter.

• It should explicitly state the settlement terms, payment dates, and other conditions.

• After completing the settlement, pay the amount in full within the given time.

• Get a No Due Certificate (NOC) or Final Settlement Letter from the bank after the payment.

• After the settlement, make sure the bank updates the “Settled” status in your CIBIL report.

• This can affect your credit score, so inculcate good financial management habits to improve it in the future.

What is the impact on the CIBIL score after a Loan Settlement?

A settlement can hurt your credit score. The impact can be seen in the following ways:

• After the settlement process, your credit report records that you have “settled” your debt. This entry remains in your credit history for 7 years and can be viewed negatively by lenders or other creditors, which can affect your chances of getting a loan in the future.

• Since a settlement means that you have not repaid the entire debt, when you try to get a new loan in the future, banks may reject your application or offer you loans at higher interest rates by looking at your credit score and report.

• After settlement, if you have a Loan or other credit line, your credit limit may be reduced as creditors think you may be a high-risk customer.

• If your credit score drops, it may be difficult for you to get a loan, Loan, or any other type of credit facility. This can also affect your financial stability, especially if you face a financial emergency in the future.

• When you settle with your bank, you are not paying off the entire debt, but a certain amount that is less than the principal amount. This is viewed negatively by the credit bureaus, as it shows that you have been unable to repay your debt. As a result, your credit score may drop.

What are the advantages (Pros) of doing a Loan Settlement?

Let us know what the benefits of doing a Loan Settlement are:

• While settlement will bring down your CIBIL score, provided you exercise financial responsibility after settlement and settle your other loans and bills punctually, you will improve your score over time.

• In a Loan Settlement, you pay a specific sum at one time, which settles your debt entirely. It may be helpful to the persons who desire to come out of debt by increasing a little money at a time.

• Mental tension grows through rising debt and bank calls. On settlement, you are free from this concern, and you may concentrate on better financial status again.

• If your Loan dues have become very high, and you are unable to repay them, then a settlement can give you great relief.

• When you do not pay your Loan continuously, the bank can send a legal notice to you and can also send a recovery agent.

• The interest on Loans is very high, which can be up to 30-45% per annum. If you are not paying on time, the interest and late payment fees keep increasing continuously.

What are the disadvantages (Cons) of doing a Loan Settlement?

Let us know in detail what the disadvantages of doing a Loan Settlement are.

• In some cases, when you go to take a loan from another bank in the future, the bank may ask you to repay the entire previous settlement amount after looking at your credit history. That is, if you had settled by paying Rs 50,000 on an outstanding amount of Rs 1 lakh, then the new bank can demand the remaining Rs 50,000 from you.

• If you have settled a Loan with a bank, then the same bank can refuse to issue you a Loan again in the future.

• Doing a Loan Settlement can spoil your relationship with the bank. The bank sees it as if you have not fulfilled your financial responsibilities completely, due to which you may face problems in banking services in the future.

• The biggest disadvantage of a Loan Settlement is that it spoils your CIBIL score. When you settle with the bank and pay a lesser amount instead of paying the entire dues, the bank reports it in “Settled” status. This status can remain in your credit report for up to 7 years, which may make it difficult to get a loan or a new Loan in the future.

• If you have done a Loan Settlement once, banks and other financial institutions may consider you a “high-risk customer”. This may cause problems in getting a home loan, personal loan, or business loan, or the bank may give you a loan at a higher interest rate.

Conclusion

In today’s time when loans are available for everything – whether it is personal expenses, buying a mobile or shopping with a credit card – many times we get trapped in multiple loans at the same time. Paying EMIs on different dates every month, managing different interest rates and facing repeated calls becomes really difficult.

In such a situation, Debt Consolidation can prove to be an easy and sensible way. It means taking just one loan by combining all your small and big debts so that you can repay all the other debts and focus on just one EMI in the future.

This method not only makes your EMI easy, but also helps in your mental peace and financial planning. If you take a new loan at a low interest rate and pay its EMI on time, then it can also improve your credit score and it can be easier to take a loan in the future.

Frequently Asked Questions (FAQ’s)