A lot of us will utilize debt at some point in our lives, since we lived in a debt-based economy. Sometimes this debt becomes too much of a burden to us and we need a way to manage it. This is where a debt consolidation loan comes in, people often take consolidation loans for different reasons.
A debt consolidation loan is a loan to you use to pay off multiple existing loans. It combines all your debts into a single debt with one repayment. What happens is that you apply for this loan from a credit provider, the credit provider pays off all your existing debts and you are left owing the credit provider.
The main reasons why people choose to take a consolidation loans are interest, time and simplicity. It’s generally advisable to take a consolidation loan that has a lower interest rate. This can end up in you paying off less if you had accumulated high interest debt. You have the option to restructure the time that you will take to pay off the loan, this can result in a lower monthly instalment; giving you a breathing room.
Does a debt consolidation loan impact your credit score?
Yes, a debt consolidation loan does affect your credit score to some extent. It might cause a temporary dip in your credit score. Not all is gloom as it can positively affect your credit score in the long run.
You need a good credit score to quality for a debt consolidation loans. Credit providers will run a hard inquiry on your credit history. A hard inquiry on your credit history negatively affects your credit score but it only accounts for 10% of your overall credit score.
A debt consolidation loan might make it easier to pay off your debt in time, which also affects your credit score. Whether or not you pay off your debt in time accounts for 35% of your overall credit score. A debt consolidation loan will also positively affect your credit utilization rate, which makes up 30% of your overall credit score.
Risks of a debt consolidation loan
You might not get a good interest rate if you have a bad credit score. This will end up with you paying more money than you would have with your existing debts. Credit providers go around this by asking you to use your home equity or car as security. This might get you a lower interest rate but you stand a risk of losing your home if you can’t make the payments.
Another risk is that you might need extra loan to finance other things in your life. You might end up utilizing your credit cards again and find yourself paying the debt consolidation loan and your credit cards. This can be too much of a burden to carry but it’s not unheard of. Try to reduce the timeframe of your loan in order to avoid this.
Conclusion
This was a guide on how debt consolidation loans work in South Africa. Do you have any thoughts or questions? Comment below.
