5 Debt Consolidation Myths Debunked
Debt consolidation allows you to pay off two or more loans with one loan at a lower rate, saving you more than half in interest payments.
Despite the benefits of this financial tool, there are still several myths about what it really is and its advantages. This article showcases five things that are often said about debt consolidation, but are not true:
(1) It affects your profile in credit bureau
This myth is due to the fact that consolidation is confused with other debt payment alternatives such as debt forgiveness, which does leave a blotch on your credit history and can affect you when applying for future credit.
Remember, consolidation protects your credit profile. It can even help you improve it by increasing your experience in credit management, since you will understand key financial concepts such as the annual interest rate of a loan and use those learnings to your advantage.
Changing your debt also helps you improve your credit score, since if you have a lot of debt, closing the most expensive loans will raise your score.
(2) I will be charged a lot of interest
This thought arises from a sad reality: traditional financial institutions offer very expensive loans especially personal loans.
However, debt consolidation loans have low and affordable rates for several reasons:
- They are aimed at people with good credit history, thereby reducing the risk of an increase in non-performing loans.
- Debt consolidation is a strategy that focuses on saving on interest and not paying more.
(3) It will take me longer to pay my debts
Many people think that by consolidating their debt, it will take longer to pay it off. This misconception is due to the belief that consolidation and restructuring are the same thing. But in reality they are two different financial tools.
Debt restructuring is when you negotiate an extension of the repayment term of a loan. For example, if you had a 12-month loan, you will now pay it over 18 or 24 months.
The main advantage of a restructuring is that you will be able to pay at lower monthly amounts. However, it also means that the interest to be paid will increase and, of course, it will take you longer to pay off the debt.
In contrast, by reducing interest payments, consolidation allows you to reduce the terms of your debts, saving time and money.
Related reading: Getting out of debt without borrowing
Other advantages of this tool are:
- Greater certainty, since the amounts you will pay are fixed, with a fixed annual rate and terms from six to 36 months.
- You will know exactly how much and when to pay. So you will be able to plan your finances better and consider the money you will save for other purposes, such as creating emergency fund.
(4) It is for those who are late with their loan payments
Debt consolidation loans are especially offered to borrowers with a good credit history and who are consistent in their repayments. Anyone not meeting these application requirements, will most likely be rejected.
If you want to pay off your debts, but you have financial problems or your credit history is not so good, there are other alternatives:
- Restructuring: This is when you negotiate the extension of the payment term of your credit with the financial institution that granted it to you. Although your monthly payments will be lower, it will take you longer to pay off the debt and you will pay more interest.
- This is the option of paying off your debt at a lower amount than the original amount. However, as mentioned in the first point, it will affect your credit history because the financial institution will report to the bureau that you paid at a discount and that is not well regarded.
(5) Banks will continue to charge interest
Changing your debt specifically prevents banks from continuing to charge high interest rates.
If you’re tired of paying more than 70% annual fees on your credit cards and personal loans, consolidation will help you get rid of that burden.
Hi, I am Nikesh Mehta, owner and writer of this site. I’m an analytics professional and also love writing on finance and related industry. I’ve done online course in Financial Markets and Investment Strategy from Indian School of Business.