People take loans to achieve their short- and long-term financial goals in anticipation that they will repay the debt in the future. While many are able to do so in time, some fail and their dues snowball damaging their credit scores. Here are a few points to remember while planning debt consolidation.
Identify target debts
First segregate your loans on the basis of interest rates. Long-term high-interest debts could be on top of your priority list while short-term low-interest debt may come down. Debts such as personal loans, credit card dues, etc., could top the list whereas low-interest loans such as housing loans, car loans, etc., may come lower down. You may also focus on consolidating only the loans on the top of your list.
Estimate prepayment, pre-closure charges
Some loan products such as personal loans may levy prepayment penalties or pre-closure charges if you repay them partly or wholly before the scheduled tenure. Check the amount you would have to pay if you consolidate those debt products and also consider other riders in terms of, say, the timing of pre-closure. If the prepayment/pre-closure penalties are less than the total expected interest saved by debt consolidation, go ahead with it.
Select low-interest long tenure loan
For debt consolidation, you should take a new loan with a lower interest rate, long repayment tenure, and no prepayment or pre-closure charges. If you have an existing home loan with a good payment track record, you may apply for a home loan top-up to consolidate other debts. If this is not feasible, taking a securitised loan like a loan against a property that typically comes with a low interest rate, long repayment tenure, large loan quantum capacity, and low processing fee or minimal to zero prepayment charges could help in consolidating your existing debts. Other viable options could be a gold loan or a loan against fixed deposit if the approved loan amount could accommodate your other problematic debts. Taking an unsecured loan as a debt consolidation tool makes sense if the applicable interest rate is lower than the loans you aim to clear with it.
Prefer a new loan with low cost
If all your loans are with the same bank, check the option of getting a single big loan for closing the existing debts. You can also negotiate lending charges with your bank. If you have multiple debts with different banks, first get the approval of a new loan from the cheapest lender and then use the fund to repay all the existing loans.
Finalise a repayment period in sync with your financial goals. However, it is best to repay your loans as soon as possible, thus saving on interest payments and becoming debt-free. Loan consolidation is a smart way to manage your debts, but it is, in no way, freedom from your debts unless you clear the consolidated loan.
The writer is CEO, BankBazaar.com