If you find yourself with multiple lines of credit from different lenders, you need to figure out a strategy to effectively start paying them off. While it would be a lot easier to just pay cash for everything, this often isn’t an option, with the average UAE resident saddled with AED 42,571 of personal debt.
Between car loans, student loans and credit card payments, trying to manage different debts all at once can become draining – and not only for your finances. If you find yourself with multiple loans and debts then debt consolidation could be worth considering.
What is debt consolidation, and how can it help your finances?
Debt consolidation, or re-financing as most banks like to call it, is a loan you take out in order to pay off several other loans – even if they are from different banks. You can combine multiple debts into a single, larger debt usually with more favourable pay-off terms like a lower interest rate, lower monthly installments or in some cases sometimes both. Consolidation focuses mainly on unsecured debts such as credit cards, monthly bills and educational loans.
The theory behind consolidating all your debt is that one monthly payment for everything is easier to manage. Making one repayment every month to one lender can help significantly when it comes to trying to become better at managing your money.
With that in mind, consolidating your debts doesn’t actually reduce your debt amount (that would only happen if you chose a debt settlement). You may feel like a debt burden has been lifted but all the money you owe will still need to be paid in full at some point. But knowing where all your debt is and reducing your monthly payments will become easier to keep track of. You will also have the convenience of dealing with just one lender.
Another convenience that makes people sway towards a debt consolidation is the lower interest rates that often come with these loans. If you have multiple credit card bills with high interest rates then transferring to a low interest rate option will help you stay on top of your payments. The average interest rate applied to credit cards tends to be higher than 30% or more. But if you find the right consolidation plan, then you could reduce the interest rate to around 10% or less. And since the interest rate is lower, each payment you make puts more of a dent into your actual debt instead of getting drained away on added interest charges.
Although consolidating all your debt may sound like the perfect solution to all your problems, remember that it isn’t for everyone and it isn’t always the best way to get out of debt. It looks good on paper – it only helps those who will then adopt a sensible approach to their finances. There’s no doubt turning high-cost credit into low-cost debt is a good way to free up some cash, but if you go and start spending the spare cash then eventually you will end up at the beginning again. Depending on your finances, considering alternatives first could make better sense for your situation.
You need to ensure the deal you’re getting on your new loan is going to be beneficial in the long run for your finances. Yes, you might have lower, better monthly repayments but at the end of day you’re only extending the length of time you’re spending paying back your debt. So while it saves you money in the short-term, you could end up paying much more in interest payments in the long term.
And if you go with a debt consolidation plan, you’re typically required to stop increasing your overall debt, which often includes limiting the use of your credit cards, or to stop using them completely – which isn’t necessarily the most convenient situation.
Making an informed decision
In order to get the best plan for your finances, it’s important to shop around for the best deal. Most lenders want to make their money by stretching out the term of the loan longer than your previous debts. If you find that most lenders or banks are offering loans that last longer than what you’re trying to pay off now, it may make more sense to look at other options as you wouldn’t want to risk paying more in interest. Compare the length and cost of the consolidation loan to your existing loan situation.
Not only do you need to consider how much you could be paying in the long run, you need to make sure your credit isn’t affected because of it. By rolling over your existing loans into a brand-new loan, you’re likely to see a negative impact on your credit score. The credit bureau favours long-standing debts with consistent payment histories. Replacing debts before the original contract has finished could be viewed negatively.
Replacing several multiple-rate loans with one, fixed rate monthly payment certainly simplifies life. But don’t consolidate just for convenience. And remember, consolidating debt alone doesn’t get you out of debt – improving your spending and saving habits does. If you do combine your debts, resist the temptation to run up balances on your credit cards again. Consolidation is a tool to help you get out of the debt cycle, not to land you back in it.
If you’re not ready to consolidate your debts just yet but need financial help, click the link to compare the best personal loans from the leading lenders in the UAE!