Brief Discussion on Debt Consolidation in terms of Credit Cards

By PolicyBazaar
  | Published: 24 November 2020 | Last Updated On: 29 December 2020
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Before this global pandemic took place, the financial advisors usually advised that the first and foremost priority should be given to debt payoff. However, these days the focus has shifted to savings due to unemployment and other uncertain conditions.

It is very essential that you maintain an emergency savings account. And although the experts recommend that you save at least the expenses worthy of 3 to 6 months in a savings account with a high-yield, having around AED 1,000 saved is a good start for the same. However, it is hard to understand the objective of prioritizing in case you have a lot of debt on your credit cards and not enough savings.

Till the time you are making the minimum payments well on time, the credit score remains in fine shape and the savings will assist you in preparing for financial surprises that may arise in the future, like losing your employment, being furloughed, or losing revenue.

But credit cards hold the highest rates of interest amongst all kinds of credit products. In case you have recently decided on not prioritizing the payment of your outstanding credit card amount so that you are rather able to pad your nest egg, then you may end up making payment of a staggering amount in terms of interest in the long-term.

One of the solutions is making use of a personal loan for consolidating your debts on the credit card into one payment in a month. Usually, this will result in a lower rate of interest and may help you in interrupting the debt cycle.

In this article, we have explained what exactly debt consolidation means, how does it work, and why it can help you save money for the long-term.

What does Debt Consolidation mean?

In case you have an outstanding debt on multiple credit cards, applying for debt consolidation is a good option for you. You can make use of this loan for clearing the debts on your credit card, then make the repayment of this loan in equal monthly installments, generally with a lower rate of interest than you would have paid on your credit card. Generally, personal loans have a fixed-rate, which means that the APR remains locked in for the entire lifetime of the loan, and you can pay the same amount monthly till the time it gets paid off. This is considered to be a benefit over credit cards that include variable APRs, which may go up & down.

You can obtain a loan from a traditional lender, such as a bank, or through a peer-to-peer lending company online. The banks usually have traditional standards that the consumers should meet for getting the loan approval. This means that you will require a significant history in borrowing with the payments being done on time, a qualifying credit score, and a high debt-to-income ratio, which proves that you have resources for affording the payments per month. On the flip side, the peer-to-peer lenders have slightly more relaxed and non-traditional needs.

How does Debt Consolidation Work?

These loans are the same as a balance transfer credit card with a 0% APR duration; however, they function in a little different way. To start with, balance transfers generally levy a fee between 2-5%, unless you apply for a no-fee balance transfer credit cards. This card needs excellent credit for qualifying, while there are many personal loan alternatives for people with good credit and fair credit.

Whenever you more from debt, unlike a balance transfer facility, when you opt for a consolidation loan, the amount of cash gets deposited in your bank account directly, which you can make use of for paying off all the credit card debt in one go.

Then, you can pay back the lender with equal monthly payments over a time period, which is determined while applying for the loan. After the personal loan amount is repaid completely, the credit line gets closed and you do not have any access to it.

Just like any other loan, you will have to pay a rate of interest on debt consolidation loans also. But unlike rates of interest on credit cards, an APR for a personal loan would be lower (depending on the creditworthiness of the applicant).

Generally, the interest payments are calculated in your payments monthly and divided throughout the lifetime of your loan. Most of the loan tenures range between 6 months to 7 years. The longer your loan tenure is, the lower your payments every month will be. But you will be charged more rate of interest over time, hence it is best to go for the shortest loan term that you are able to afford.

Moreover, some of the lenders charge an origination or sign-up fee. However, there are many no-charge options with different rates of interest based on the credit score. You must apply for a no-charge personal loan whenever you can.

Debt consolidations loans are good options in case you have various credit card balances. When you merge these balances in one, the personal loan is a helpful way for streamlining the bill payments because you will just have one account to keep up with.

In a Nutshell!

Debt consolidation loans could help you in streamlining the budget by allowing you to make a payment off your debts on a simple payment per month. Shifting the debt on your credit cards to a personal loan will also generally lead to a noticeable jump in the credit score because this will make your credit utilization rate go down effectively.

However, even with the simplicity and convenience of a debt consolidation loan, you must pay proper attention to the rates of interest as well as charges while inquiring about the pre-approval. Ideally, you will be able to find a loan, which can help you in making your monthly payments more manageable and at the same time also help you save on the rate of interest in the long-term.