What is a Debt Consolidation Loan and How Does it Work?

Debt consolidation is the act of clubbing all your existing loans together and paying them off as one single debt.

The biggest advantage of taking a debt consolidation loan is that you don’t have to worry about connecting with multiple vendors for repayments. There’s no need for managing multiple credit cards and the EMIs you pay are dedicated towards a single big loan.

There are some cases where you cannot apply debt consolidation. For example, you cannot take a debt consolidation loan for paying off pending EMIs for liable or secured assets (such as a home loan).

However, for unsecured loans like personal loans, education loans, and credit card dues, you can apply for a debt consolidation loan to clear them up.

Some organisations these days offer secured debt consolidation loans for individuals where they put up their property or business assets as the collateral.

Unsecured debt consolidation loans are hard to apply for and charge higher rates of interest. Most banks aren’t willing to give out individuals unsecured debt consolidation loans but there are NBFCs, fintech startups, and private organisations that disburse these loans as long as the borrower’s profile is verified and they demonstrate sufficient creditworthiness.

The best part about these loans is that the interest rates remain fixed and do not fluctuate. This means your monthly EMI repayments stay the same and don’t suddenly change, thus giving borrowers peace of mind.

Advantages of Debt Consolidation Loans

There are various reasons why you’d want to opt for a debt consolidation loan. Here’s a list of the benefits:

• One Single Liability – It’s hard enough to keep track of multiple EMIs and repayment. Going for debt consolidation takes care of this legwork since your lender takes care of the communications. Your only duty is to make sure you make your EMI payments on time for the debt consolidation loan you applied for.
• Lower Interest Rates – With multiple different loans, you have varying interest rates. But with a debt consolidation loan, you have to worry about a single interest rate. The payoff is lower too and it makes the monthly repayments lesser too.
• Paperless Process – If you’re applying for a debt consolidation loan online, you’ll find that the entire process is paperless. You can file your application digitally and you’ll find that lenders disburse the amount in just a few days if you meet their borrower requirements.
• Flexible EMI Tenure – Debt consolidation loans can have a flexible repayment tenure of anywhere between 2 years to 20 years. Self-employed individuals can get a tenure of up to 18 years while salaried individuals are liable for more.

Debt Consolidation Loans vs Debt Settlement

The key point to remember about debt consolidation loans is that they don’t completely erase all your debts. They simply club your loans together and transfer them to a single lender. As a borrower, you become responsible for making repayments to a single lender.

Debt settlement works a bit differently and aims in providing credit relief to borrowers. Here, negotiations are done with lenders to reduce the loan amount or interest rates instead of cutting down on the number of lenders by transferring the debt to an organisation.

There are many credit counselling services and organisations that help in doing debt negotiations with organisations and providing relief to borrowers, although they don’t directly give out any loans on their own.

How Does It Work?

Let’s say you’ve taken a loan of Rs 1 lac over a period of 2 years with an interest rate of 12%. And you have another loan of Rs 2 lacs which you have to clear within a year, its annual interest rate being 10%. The monthly EMI payments for each of these loans may come to around INR 5170 and INR 5830 respectively.

With a debt consolidation loan, your monthly EMI payment would amount to INR 6000 combined. However, the trade-off is that you get a longer tenure for making both the repayments on your existing debts. Instead of making multiple payments to lenders, you can now make a single EMI payment every month and end up saving money on interest. The longer tenure also gives you peace of mind as you know that you can handle your repayments a lot better. Debt consolidation gives you a favourable structure for making repayments and makes it convenient to pay off multiple small loans together by applying for a big loan.

Make sure you identify all your financial obligations and liabilities before going for this type of loan. It’s always a good idea to talk to an advisor before applying for debt consolidation if you’re not sure whether or not to go for one based on your financial circumstances.

What Are The Eligibility Requirements?

If it’s your first time applying for a debt consolidation loan, you’re going to have to make sure your KYC documents are with you. Lenders look for documents such as:

• Proof of employment and stable income (at least 2 months’)
• Letters from credit agencies
• Bank statements
• Proof of Identity

You must also be a resident of India and be 25 years of age or older. If you’ve been self-employed for years and have taken loans before the age of 23, you can still go ahead and apply for a debt consolidation loan before this age limit criteria. Your lending organisation will decide which creditors you pay off after your debt consolidation loan is approved. The way this works is you pay off your highest-interest loans first and clear up the remaining ones over time.

However, some organisations may allow you to pay lower-interest loans in the beginning and later clear the higher-interest ones. This will depend on your lender whom you’re applying for a debt consolidation loan through or the lending organisation. Additionally, you will have to demonstrate your creditworthiness and show your CIBIL Score when applying for these types of loans.

How Does A Debt Consolidation Loan Affect Your CIBIL Score?

If you take a debt consolidation loan and pay off the principal portion of your loan sooner, it can attract various credit lending organisations to your profile. The sooner you clear out the existing loans, the higher your CIBIL rating will be.

Also, the period involved in making all your repayments becomes shorter since you’re clubbing different debts into a single EMI. Overall, it makes it much easier to manage your existing debt repayments. You can also get a much more reasonable interest rate when you go for debt consolidation and sometimes, you can cut that number to one-thirds depending on what your current CIBIL rating is like.