How To Avoid Defaulting On A Consolidation Loan
Consolidation loans are one of the most common strategies people use to pay down consumer debt. Debt consolidation has several advantages. When done right, it can make the path to debt freedom much more manageable.
That being said, those hoping to have success with this strategy must be responsible and exercise a high degree of discipline. Those who fail to do so risk defaulting on their consolidation loan, which leaves them in a worse position than before.
Read on to learn about debt consolidation, it’s benefits, and how to avoid defaulting on one’s consolidation loan.
What Is Debt Consolidation
The general premise of debt consolidation is simple, an individual takes out a loan that they then use to pay off their outstanding debts. This leaves them with one single monthly payment, effectively merging all their debts into one.
Benefits Of Debt Consolidation
- Lower interest rate: Those who are consolidating credit cards and other high-interest rate debt will be pleased to find that consolidation loans typically come with comparatively much lower interest rates. Whereas credit cards carry an average rate of 19% - 21%, these loans can range anywhere from 5.99% - 14.99% for most borrowers
- Single payment: Since this loan combines all outstanding debts into a single monthly payment, it makes it much easier to keep track of one’s debts
- Lower monthly payments: Reduced interest rates mean smaller monthly payments. This is especially true if one is being charged late payment fees for any accounts that they are behind on
Avoiding Defaulting On Debt Consolidation Loans
Consolidating high debt balances is great for relief. Still, borrowers should embrace the following practices to ensure debt relief doesn’t turn into debt default.
Change Spending Habits
When one goes through the process of debt consolidation they’re not typically required to close the accounts that they pay off. For example, if one were to use this loan to pay off the balances of three credit cards, there’s no stipulation in the loan that states that the borrower must cancel these cards once they have been paid.
While this is a good thing, many people can’t resist the urge to start spending with their balance-free credit cards. Therefore, many end up in a worse position than before.
Consolidating debt is only worth it if the borrower refrains from exercising the poor spending habits that got them into debt in the first place.
Develop A Budget
As touched on in the above point, bad spending habits are the primary cause of debt issues. It’s true that some people find themselves in large amounts of debt due to an emergency or unforeseen circumstances. However, most cases are a result of people spending more than they earn.
Due to this, one must develop a budget to ensure that they’re living a lifestyle they can afford. If one tallies up their total monthly expenses and this amount exceeds their monthly income, some serious changes need to be made.
Inquire About Debt Forbearance
Debt forbearance is an agreement between a creditor and borrower to put a temporary pause on debt payment. For example, the COVID-19 pandemic has resulted in one of the highest unemployment rates since the great depression. In response to this, many creditors have offered debt forbearance to their customers.
Aside from the pandemic, many lenders are willing to offer forbearance to borrowers for a variety of reasons. Keep in mind that this pause in payment won’t be granted automatically. To receive a hold on payments, the borrower must put in a formal request to their creditor. Whether or not this request is granted is entirely up to the lender.
Every state offers its residents access to non-profit credit counseling services. These counselors will review an individual's situation and then help them develop a plan to get back on track with their loan payments.
Sometimes the only way out is to increase one’s income. While this option is likely unappealing to most people, it’s important to keep in mind that it’s not forever. Some people may need to pick up a part-time job on the weekends until they can pay down their debt to a point where the monthly payments are more manageable.
Defaulting on a consolidation loan will hurt one’s credit score and financial situation. This will make it even more difficult to get out of debt. Because of this, it’s of the utmost importance that one takes special care in exercising responsibility with their debt obligations.