It is wrong to think that debt consolidation can make your debt disappear miraculously.
This step involves the restructuring of debt so that it is easier and more comfortable to repay. You will have more cash left during the month and you may be able to save money on the new loan as well. Still, in order for this plan to work out, you must ensure that you will be a prompt payee and that you will avoid getting into more debt.
It is quite easy for any modern person to get into debt given that there are numerous things to spend money on while income is always limited. Perhaps the biggest trap of debt consolidation is the misconception that you will have the freedom to spend as much money as before. Given this, the consolidation of outstanding debt must be accompanied by a major improvement in spending. You need to become more responsible towards money and more disciplined as well. This will enable you to spend less than before and still enjoy life fully.
You need to understand that the finance companies which provide debt consolidation are in for profit as well. They will charge interest on the new loan and you will have to make monthly payments. If you default on the loan, you will get into serious trouble. This is yet another important reason why you must have a clear strategy for getting-debt free. It must be based on a strict budget and spending rules.
There are various types of loans and credit lines and each one has a different cost. Home loans have the lowest interest rates. These rates are the closest to the Official Cash Rate set by the Reserve Bank of New Zealand. The credit cards, cash advances and payday loans have the highest interest rates.
There are flexible home loans which can be topped up plus home equity loans which are also known as second mortgages. All of these can be used for borrowing against the equity of your home at a much lower interest rate. Such loans can be useful for buying major items or for renovating the property. In any case, the ideal strategy is to pay off such loans as quickly as possible. This is because a longer term will result in a larger interest payment, even though the regular payments are lower. With a longer term, the cost of the loan can be as high as that of an unsecured personal loan which comes at a very high interest but has a very short term.
The Simplicity of Debt Consolidation
How does it work?
All outstanding balances on your personal loans and credit cards are wrapped into a single loan which has a single regular payment. The term is determined in advance. With a single instalment, you will never have to worry about complex budgeting or about missing a payment and getting into trouble. Typically, the interest rate on the consolidation loan is lower than the average rate on all previous loans and credit cards. With a consolidation loan, you will have smaller payment and larger disposable income during the month.
Understanding Home Debt Consolidation
This option involves using the equity in your home for securing the debt consolidation loan which you take out. In this way, you can pay much lower interest rate. Whether this option can work out depends on how much equity you have in your property which is determined by the outstanding balance on your home loan. If your equity in your property is greater in value than the size of the debt you have accumulated on personal loans and credit cards, you will be able to take out a consolidation loan backed by your house.
Usually, the debt consolidation loan amount does not exceed the amount of debt which the borrower has. Basically, you will not get free cash to use after the deal is completed. You have to ensure that you will make the regular payments on the new loan promptly. If you default, the lender will have the right to take over your house since it is used to secure the loan.
There are two important aspects of home debt consolidation which you must take into account. It will come with a lower interest rate compared to the unsecured loans and credit cards which had got you into debt in the first place. The rate will be the same or close to the one on your home loan. Due to the lower interest rate, the regular payments will be smaller. This will give you more free cash to spend. The other major factor to consider is that the loan will have a fairly long term. It may be as long as the remaining term of your home loan. A longer term will result in even smaller monthly payments. This will increase your disposable monthly income even further.
Everything seems perfect up to this point. You can extra money to spend during the month while you have to deal with a single loan payment. However, things are not that simple. With a longer term, your debt consolidation loan will become much more expensive. This is because interest will be charged for a longer period of time. As a result, the total cost of the new loan will be higher. If you want to save money, you have to make as many and as large additional payments as possible. You just have to ensure that this is not associated with any penalty fees and charges. Furthermore, you have to adopt a precise repayment plan, a strict budget and core spending rules.
The biggest threat to debt consolidation is to keep your previous pattern of spending, as pointed out earlier. You need to look at the new loan as a tool for saving on interest and not as an indirect source of more free cash. As long as you are focused on saving on interest, you will be motivated to modify your spending habits and to adopt an effective budget so that you can pay off the loan early. With the right action plan, you will get out of debt quickly and enjoy true financial independence once again.
You must always keep in mind that if you fail to make the payments on the debt consolidation loan, you will risk losing your home since it is used as security. This is a huge motivating factor for adopting a repayment plan based on careful budgeting and spending. You must make full use of the available opportunity while reducing the risk to the lowest possible minimum.
Terms to Know
The idea behind debt consolidation is fairly simple to understand, but you have to be familiar with the main terms used by lenders to ensure that everything will go smoothly and that you will get the deal which you expect. Use the following definitions to help you out.
The process involves the transferring of all outstanding balances on personal loans and credit cards to one account. The main goals are two - getting a smaller regular payment, which allows for more efficient money management, and saving on interest. The consolidation is effective when the interest amount and other charges paid during the month are lower than the previous ones.
Unsecured and secured debt consolidation loans
In case of secured debt consolidation, you have to use an asset as security for the new loan. This is typically your house, but it may be another asset with sufficient value. With an unsecured loan, you will not have to use an asset as security.
An asset is used to secure the loan. This asset is usually the borrower's house, but it can be a car, a valuable work of art or even an investment portfolio. If the borrower fails to make the loan payments, the lender will have the right to take over the asset and to sell it in order to recover their loss. A secured loan is less risky for the lender and riskier for the borrower. This is the reason why the interest rate is lower compared to those on unsecured loans.
The Consolidation Loan Market
There are specially designed debt consolidation loans available from various lenders in New Zealand. The list includes commercial banks, credit unions and smaller finance companies. It is also possible to get such a loan through a broker whose job is to search the packages of different providers and find the one which suits your needs and requirements most perfectly. There is yet another option available to you. If your bank or the lender which currently offers the lowest interest rates has no consolidation loans, you can apply for a regular unsecured or secured loan and use it to pay off your existing debt. If you have good credit history, your chances of getting a superb deal will be high.
It is standard practice for the debt consolidation loans in New Zealand to be tailored precisely to the needs of the client. That is why you should be prepared to sit down with a specialist and to discuss your precise requirements. You should have a clear idea of how much you can afford to pay back on a regular basis. You must check the qualifying criteria set by the lender in advance. If you have any blemishes on your credit record, you must take appropriate action to remove them or to repair them as best as possible.
It pays off to compare the debt consolidation offers of different lenders. In this way, you will be able to select the best solution for you. Additionally, you should check with your bank whether they will be able to offer a special deal to you as a loyal customer.
When you compare debt consolidation loans, you have to focus on a set of important factors. These include the interest rate, the fees and charges, the term of the loan and the repayment structure. You should calculate the total cost of the loan as well. The lower it is the better. You have to check specifically for any penalties for making additional payments and for paying off the loan early.
You must check specifically whether the provider of the new loan will pay off your outstanding debt on your other loans and credit cards. This will be the much easier option for you as you will not have to deal with each loan and credit card yourself. Besides, the lender will have certainty that you will not get into more debt. If this service has additional fees and charges, you have to confirm that they are reasonable. In any case, you must ensure that all of your previous accounts are closed so that you can have a fresh start.
Finding the Ideal Debt Consolidation Loan
There are some important criteria which the debt consolidation loan that you will use must meet. These are:
- Loan amount which is sufficient for the repayment of all outstanding balances on your personal loans and credit cards
- Interest rate which is lower than the average rate which you currently pay on your loans and credit lines
- Regular payment which is smaller than the total payment which you currently make on unsecured loans and credit cards and which fits into your budget given your income and spending
- Loan insurance which is designed to pay off the loan in case you are no longer able to earn employment income due to an event such as death, disability or other
- Fees and charges paid at the time of the granting of the loan which are reasonable and do not reduce considerably or eliminate the benefit from the lower interest rate
It is best if you plan the repayment of the debt consolidation loan in advance so that it matches your long term financial goals. Once you have a plan, you need to adhere to it strictly. The sooner you pay off the loan, the more you will save. At this point, you will have the freedom to achieve any financial and personal goal.