Debt Consolidation: Is it a good choice? Are there risks involved?

With loans and credit card payments, it can be difficult to keep track of debt and expenses accurately. A person may forget to repay a loan instalment or find it difficult to manage all their dues every month. In this context, debt consolidation may be the answer. The concept allows borrowers to refinance their debts by bringing in all dues under a single loan. The move can simplify your debt burden and ensure that you have fewer bills to deal with.

As with any option, there are certain risks involved in consolidating your debt. It becomes important to know why debt consolidation may be a good choice and what are the risks surrounding the concept.

How does debt consolidation work?

Debt consolidation involves either a new loan or a balance transfer credit card. It offers borrowers the chance to repay their debts in a systematic manner, often at a lower interest rate. The idea is to merge all your dues into one loan. This can either result in a lower monthly payment, shorter loan tenure or increased credit score.

Consolidating your debt has several advantages. It can streamline your finances, reduce debt burden and help you set aside money for investment purposes.

What are the risks involved in debt consolidation?

There are certain disadvantages of consolidating your loans. The risks range from consequences of missing payments to higher interest rates.

Upfront charges: While debt consolidation may seem like the best choice, borrowers are often upfront charges, including closing charges, annual fee and balance transfer costs. This can increase the amount you have to pay.

Missing repayments can set you back: If you miss a repayment after debt consolidation, you will have to pay a late payment fee or a returned payment fee if the funds are insufficient. This can lead to more burden on your finances.

Higher interest rate: If your credit score is low, the lender may charge you higher interest under consolidated debt. If your loan tenure is extended under the terms of refinancing, your interest rate is likely to increase.

Won’t change risky financial habits: Debt consolidation may not help you fix any underlying financial habits that may lead to repayment issues in the long run. Managing expenses and budgeting for repayments are some prudent habits that can help borrowers in the long run.

Is debt consolidation a good idea?

If borrowers have a number of high-interest loans, debt consolidation can be a good idea for them. Before opting for merging their dues, individuals need to ensure that their credit score and ability to make monthly repayments is solid. This can help them avoid any pitfalls like late fees and higher interest rates.