While having debts can be tough for anyone, it is especially taxing for low-income families. Imagine being part of a household that worries daily about how bills will get paid on a weekly or monthly basis. When you are at the low-income level, there is little to no wiggle room for disposable income. Often, you have to resort to more loans to get by. Once you go down the rabbit hole of more debts, declaring bankruptcy may be the only option left. It is not impossible to get out of debt, even with a paycheck-to-paycheck existence. You just need to be aware of your options. When your debt load becomes too high to see a way out of it, long-term solutions may be the better route. This may be filing for debt management or debt settlement. Each method has its pros and cons. Out of all the long-term debt relief, the most manageable is probably debt consolidation.
How Does a Debt Consolidation Loan Work?
Debt consolidation refers to the act of obtaining a new loan to pay off other debts and liabilities, such as credit card debt or student loan debt. Several debts are combined into one larger loan, usually with favorable terms, like a lower interest rate or monthly payment, or both. With debt consolidation, it is easier and faster to settle what you owe. You only have a single loan to pay for every month, but it is not as simple as it sounds.
Consolidation lenders need assurances that you will pay back what you borrowed. With most consolidation loans, you need a good credit score to qualify. If you have a poor credit score, one that falls below 620, securing one may be difficult. Some lenders may also ask for collateral to lessen the risk. If you use your home as a guarantee, you may end up losing it if you cannot fulfill your obligations and make payments.
Debt consolidation should have a lower interest rate, sometimes around 10% to 20% less. With this, the amount you pay on monthly interest should decrease. Assuming that you do not rack up more debt while paying and can control your spending, you will soon be able to pay off all your liabilities. A debt consolidation loan simplifies making multiple payments, which is often confusing and taxing to manage.
Debt Consolidation Options for Low-Income Families
If you decide to consolidate your debts, there are several options you may consider. One is via a balance transfer. Under this method, you will merge all your credit card debt onto one credit card with a lower annual percentage rate (APR) using a balance-transfer card. This usually comes with a balance transfer fee of 3% to 5%, but credit card companies offer introductory 0% APRs lasting up to 21 months.
Another option for debt consolidation is by using a personal loan to pay off multiple kinds of debt. Personal loans, however, are more difficult to get compared to secured loans. Since they do not require assets as collateral, lenders only have your promise to repay your debt. It must also be noted that APRs differ across credit bands, depending on a variety of factors such as credit history and term length, so make sure to review the terms before taking this route.
The third option is a home equity loan. Some lending institutions like Alpine Credits offer debt consolidation by using your home as collateral. These loans are easy to qualify for, even if you have no income or bad credit. For this reason, a home equity loan is the best out of all the debt consolidation choices for low-income families. You may even be able to secure a lower APR than with personal loans. Read more about home equity loans and how they work in Canada.
Requirements for Debt Consolidation
Borrowers of debt consolidation loans must have the income and creditworthiness needed to qualify. Brand new lenders also tend to be more strict with qualifications, so be prepared to present documentation. These records are often about your credit history. For instance, you need to present two months’ worth of statements for each loan you wish to pay off and letters from your creditors. You may also need to submit a letter of employment.
If your financial history includes a recent foreclosure, qualifying for a debt consolidation loan may be unlikely. This is because lenders steer away from borrowers with damaged credit ratings. They also prefer loan candidates with a steady job and regular income. You also need to demonstrate that you are responsible for handling money. One evidence is showing that your monthly debt payments do not exceed about 36% of your income.
Once approved, you and your consolidation loan creditor will put a plan in place. In a lot of cases, your lender will decide the order in which your loans are repaid. If not, you have to decide who you will pay off first. One technique starts with your highest-interest debt, then the second-highest, until you are left with the lowest-interest loan. However, if you have a loan that is causing you stress, you may want to begin with that one instead.
Debt Consolidation and Credit Scores
A debt consolidation loan may raise or lower your credit score, depending on your paying habits. Paying the required monthly payments on time can help boost your score and make you more attractive to future creditors. You can also demonstrate your creditworthiness by paying the principal portion of your loan sooner. This will help keep the interest payments low, which is good because it is less money out of your pocket.
Meanwhile, you can damage your credit score if you fail to stay current on your loan payments. Adding new balances on your credit cards while you are still repaying the consolidation loan may also hurt your credit. It must be noted that your debt-to-credit utilization ratio could rise when you apply for a debt consolidation loan. When your ratio remains high for a certain period of time, it is an indication that you could be a higher-risk borrower to lenders.
Rolling over existing debts into a brand new one impacts your credit score, at least in the beginning. When you close out old credit accounts, your credit utilization rate suffers. Credit scores also favor long-term debts with consistent payment histories over short-term loans. Instead of closing the credit account, exercise prudence and refrain from using it. Remember that additional balances on your card are not good when you are still paying off your consolidation loan.
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