If you have multiple loans to service and want to repay them in one go, what would you do? Raising a fresh loan doesn't seem like a rational thing to do. You can, however, opt for it if you want to retire the current loans and consolidate them into a fresh personal loan.
You can do this if you are getting a fresh loan at a lower interest rate. Also, you should take a loan in order to consolidate it when you know that you can repay it easily without getting into a fresh cycle of debt. The consolidation makes sense when the overall amount of the loan is of a manageable level.
“Taking a personal loan to consolidate high-interest debts can be a strategic move, as it simplifies repayment and potentially lowers the interest rate, resulting in savings over time. For instance, if one consolidates credit card debt with an average interest rate of 36 per cent into a personal loan with an interest rate of 15 per cent, the savings can be substantial,” says Nitin Rao, Head of Products & Proposition, Epsilon Money Mart.
"However, it’s vital to ensure disciplined repayment and avoid accruing new debt or using the debt amount for some other purposes. As a caution, this approach is only for those who have a clear repayment plan and stable income," Rao added.
But remember that if you are consolidating credit card debt with a personal loan, you could be tempted to use the credit cards again, leading to more debt. Discipline is required to avoid accumulating new debt while paying off the loan.
I. One payment: Rather than managing multiple debts with different due dates, one can focus on only one payment. This can make it easier to stay on track and avoid missed payments.
II. Lower rate of interest: If the interest rate on the personal loan is lower than the rates on your existing debts (especially credit card debt, which often carries high interest), you could save money on interest over time.
III. Fixed repayment: Personal loans generally have fixed interest rates and set repayment terms, meaning your monthly payment amount will remain consistent. This can provide more predictable budgeting.
IV. Credit score: Consolidating your debt could improve your credit score over time, especially if you pay down credit card balances, as it could reduce your credit utilisation ratio.
“Sometimes because of bad spending habits, people get badly trapped in debt. Because of such multiple loans, their EMI becomes 80 or 90 per cent of their monthly income. This is a dangerous situation. In such a case, before additional personal loans, first check whether you can take monetary help from friends and family,” says Preeti Zende, a Sebi-registered investment advisor and founder of Apna Dhan Financial Services.
“If help from family or friends is not enough, and if you have room to accommodate a new EMI, then you can take a personal loan to close the credit card loan. This helps to lower the total EMI amount after the expensive loan gets closed,” Ms Zende adds.
I. Fees: Personal loans may come with origination fees, prepayment penalties, or other costs. These fees can add to the overall expense of the loan, potentially outweighing the interest savings.
II. Higher overall interest: Some people get a personal loan that leads to repayment period extension. While this could bring down monthly payments, it could mean paying more in interest over the life of the loan.
IV. Credit Score: Applying for a personal loan will involve a hard inquiry on your credit report, which could temporarily lower your credit score. Also, if you miss payments on the loan, your credit could be negatively affected.
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