When is debt consolidation needed?

When is debt consolidation needed?

Debt consolidation is the unification of all the credits held by an individual, even if they correspond to different entities. The procedure consists of obtaining new financing to cancel each one of the outstanding loans.

By consolidating their credits, the person commits to a single fee less than the sum of all the payments made per month. This may occur as a result of a lower interest rate or the extension of the financing term.

To explain it in another way, when the bank offers debt consolidation, it is proposing to buy the loans that the debtor owns with other institutions. Thus, a new client wins, providing better credit conditions.

When is debt consolidation needed?

In the following scenario, you will need debt consolidation.

•    When your debt excluding mortgage does not exceed 40% of the total gross income.

•    When the cash flow steadily covering payments towards the debt.

•    When you plan to prevent debt again in the future.

•    When your credit is acceptable for low-interest debt consolidation loan or credit card.

Example of debt consolidation:

Let’s look at an example of debt consolidation. Suppose that a person has credit for the US $ 15,000 in bank “A” at 12 installments and with an interest rate of 3% per month.

At the same time, he has a loan with bank “B” of US $ 20,000 to 14 installments and with an interest rate of 3.5% per month.

In both cases, we will assume that all quotas are equal. Thus, we will use the following formula:

Then, the fee is the US $ 1,506.93 with bank “A” and the US $ 1,831.41 with bank “B”. That is a total periodic disbursement of US $ 3,338.35.

Let’s suppose that you need to pay 50% of both loans. Suddenly Bank “C” offers the consolidation of the debt with new financing for the US $ 17,500. This amount will be used to cancel the outstanding loans.

If Bank “C” sets a monthly interest rate of 2.5% for the new loan and 7 payments, all equal, the fee will be the US $ 2,756.17.

Finally, although we do not consider it in the previous example, it should be noted that the early cancellation of a loan may require payment of a penalty.

Advantages of debt consolidation:

There are several advantages of debt consolidation. First, it is useful in the face of short-term liquidity problems.

For example, suppose a person loses their job unexpectedly and can no longer meet all of their financial obligations each month. So, debt consolidation is an alternative to reduce expenses.

Also, unify the loans allows maintaining a greater order. Instead of having several installments with different maturity dates, there will now be a single disbursement that can be programmed strategically.

Disadvantages of debt consolidation:

A possible disadvantage of debt consolidation is the increase in total expenses. This will depend on the term of indebtedness, which may have been extended and the type of interest that the bank sets for the new loan.

Therefore, it is important to calculate the total disbursements until the end of the financing period.

In addition, we must take into account that it will not do anything for the borrower to consolidate his debts if he reacquires other credits. This would only generate financial problems.

Debt consolidation is explained here in more detail.

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