Debt refers to when one person (debtor) owes money to the other (creditor). It is subject to the payment of the principle amount plus the interest, which is taken in order to compensate the debtor for lending money. Debt leaves the debtor with a lot of stress to deal with, for example dealing with multiple creditors, many accounts, stacks of bills and numerous calls and messages from creditors who want their money back as soon as possible.
Fortunately, there are a few ways to deal with this complicated situation for instance through debt settlement or debt consolidation. Debt settlement is when the creditor and debtor negotiate on a reduced amount than the one that initially had to be paid by the debtor. This benefits both the sides in a sense that the debtor gets the load of debt off their head and the creditor at least gets their money back quickly. However, these negotiations are time taking, costly and often difficult to be matured.
Another way to get debt free is through debt consolidation; this is where a single big loan is taken in order to repay all the other loans. Therefore, the debtor pays the loan in full which is what makes it different from debt settlement. The idea behind this is that a single creditor will be manageable to deal with than numerous creditors. This loan can be taken through the bank or debt relief companies. Just like other loans, monthly payments are also made on the loan taken but the advantage here is that comparatively the interest rates will be lower.
It is important to understand the difference between secured and unsecured loans. The former is when you take a loan and secure it against any asset. For instance, you secure a loan against your house hence if unable to pay the creditor will sell your house to get his/her money back. The latter is when loans are taken on promises and not secured against any property that can be reclaimed by the creditor. An example of unsecured loans can be credit cards. Because of the difference in the level of risk involved, secured loans have a lower rate of interest than unsecured loans.
Debt consolidation can be gained for secured debts generally easily by taking other assets as security for the loan. Sometimes, the interest payments are treated in such a way that they also decrease the amount of tax that has to be paid. If you want to consolidate a debt through unsecured loan you have to make sure that you have a good credit history. However, the major benefit is that the loan is pledged against no asset hence the level of risk is low. An unsecured debt consolidation loan is usually tough to get as most people may not meet the requirements for the loan. In addition, interest rates are higher than secured loans. This may mean that the borrower is ultimately paying the same amount of money thus not making the borrower better off.
When debt consolidation is taken the most important question that needs consideration is that which creditor to pay first. Generally, it is beneficial if the ones with the higher interest rates are paid first. However, in case other creditors are causing more emotional stress then they can be paid, thus this depends upon the situation of the debtor.
Debt consolidation needs to be taken by carefully taking into account all of its positive and negative impacts. The fact that by debt consolidation, you have just shifted your debt but have not really done anything to address the real problem should not be ignored. In addition, the monthly payment and interest rate might be lower of the new loan. But in case the payment is scheduled in such a way that it is comparatively longer than that of the previous debts, you will just end up paying more that will bring you no financial benefits.
Moreover, obtaining secured loan actually means that you are risking your assets; you may be pledging your property as security against much larger amounts than you had previously. Furthermore, debt consolidation groups often charge high monthly fees for the services that they provide. Most importantly, the debtor should always check the company’s licensing to make sure its legally operating.
So, one needs to remember that debt consolidation alone does not get a debtor out of debt, but reducing expenses and improving savings are also crucial to get rid of debt burden.
If we specifically focus on Australia, we find many incentives from the Government to avail debt consolidation. Also, many private financial and legal companies provide services to source the creditor, settle the terms and make agreement for debt consolidation.
Steven Rooyen is a husband, father, senior debt advisor and a financial consultant at Sort My Debt. With over a decade of experience in different financial fields, Steven has helped many people resolve their debt problems and provide debt negotiation services in Australia. While not doing that, you can find him reading books and roaming with friends.