When you are juggling multiple debts, you have a consolidation plan and a management plan. It can be hard to pick the one. Both options can help you gain control of your debt and save money on interest payments. It is crucial to note that both plans will have a different impact on your credit rating and the amount of debt you owe.
Most of the people confuse consolidation loans with debt management plans. Both options work differently, and hence, the outcomes are different too. There are some similarities, though. It is enjoined that you carefully consider your options and weigh up their pros and cons, so you do not rue the day.
When you are struggling to keep up with debt payments, the first question that comes to mind is whether you should consolidate your outstanding debts or you should consider a debt management plan. What would be better for you? Well, there is a straightforward answer to this question as it banks on multiple factors, such as how much debt you owe and your current financial condition. But before that, you need to understand what exactly they are.
What is a consolidation loan?
Debt consolidation is a loan that you take out in order to combine all your existing debts and use it to pay back your existing lenders. In this way, you manage to get rid of your existing outstanding debts once and for all and are left with only a consolidation loan, which is to be paid down over a period of months.
Debt consolidation is actually a personal loan that you use to pay back your existing debts, such as bad credit loans, payday loans, and no guarantor loans. You can save a lot of money on interest payments by combining your outstanding debts because personal loans spread the cost over a period of months.
Balance transfer credit cards are also a type of consolidation loan. If you have credit card debt, it cannot be transferred to a consolidation loan. You will have to apply for a 0% balance transfer card. You can avoid paying interest as long as you settle your whole debt within an interest-free period. Otherwise, you will be charged more money in interest.
Here are the pros and cons of consolidation loans:
It helps save on interest
Consolidation loans are mainly aimed at people with high-interest debts, such as payday loans. These loans keep rolling over, and henceforth the cost of the debt keeps accumulating. You can save money on interest by joining them in a personal loan. Interest rates on consolidation loans are lower than those on payday loans. This will help you save a lot of money, provided you manage to discharge your debt on time.
It helps improve your credit score
Since you will be paying down a personal loan over an extended period of time, you have a chance to improve your credit score. On-time payments are reported to credit reference agencies. If you clear your consolidation loan on time, you will see a significant improvement in your credit score.
There is a risk of falling into debt
While consolidating loans, there is always a chance to borrow more money, especially if your credit rating is stellar. It can make it complicated for you to adhere to payments. If you fall behind on payments, your credit score will be ruined, too. Once you fall into debt, it would be all but impossible to get out of it.
Consolidation loans are not always a cheaper option
Consolidation loans require you to have a good credit history. Debt consolidation loans in the UK for bad credit charge very high interest rates. Further, you will also be restricted from combining your existing debt. Consolidation is not recommended when you cannot qualify for cheaper interest rates than the average rate of your current balance.
What is a debt management plan?
A debt management plan is a method that allows you to make payment arrangements with your lenders. If you are juggling multiple debts because your financial condition is too weak to keep up with payments, you should try a debt management plan. This method to settle debt is only aimed at people who are left with little money after paying all their priority bills at the end of the month.
You will need to contact a debt management agency, which will negotiate with your creditors on your behalf for lower payments. In addition, they may ask your lenders to freeze interest and charges.
A debt management plan is completely different from a consolidation loan. At the same time, a consolidation involves taking out a new loan; a debt management plan does not. You would rather pay only one instalment every month to your debt management provider, who dole out money among your creditors.
Here are the pros and cons of debt management plans:
It helps simplify payments
One of the biggest benefits of a debt management plan is that it helps simplify payments. Instead of juggling multiple payments, you pay only one time a month to your debt management provider, who gives it to your creditors.
It helps save money on interest
A debt management plan helps save you money on interest because your provider will negotiate with your creditors to accept payments at lower interest rates on your behalf. You would certainly be able to retain some cash at hand after entering into a debt management plan.
No good credit score needed
While consolidation plans are approved when your credit score is up to scratch, a debt management plan does not require a good credit rating.
Creditors may not agree to a debt management plan
There is no guarantee that creditors will agree to a debt management plan. If a lender turns it down, you will have to continue to make payments to your lenders as you had already agreed.
You cannot use your credit cards
As long as you are on a debt management plan, you will not be able to use your credit card. Your credit card provider will cancel the plan. In fact, you will not be able to open a new line of credit or apply for a new credit card. Although it seems like you are being restricted from accessing credit, it, on the other hand, is beneficial as you will be forced not to take on credit while being on a debt management plan.
It only includes unsecured debts
A debt management plan includes only unsecured debts such as bad credit loans, personal loans, payday loans, and the like. If you are struggling with secured debts such as a mortgage and an auto loan, you would have to deal with them individually. They cannot be part of a debt management plan.
Debt consolidation or debt management plan - which is better
Both options are aimed at helping you get out of debt. Whether you should consolidate or use a debt management plan depends on your financial condition. A debt consolidation plan is better when you can qualify for a personal loan at lower rates than you have been paying on your existing loans.
However, a debt management plan is a suitable option when you cannot qualify for a consolidation loan. If you cannot decide what you should do to get out of debt, you should talk to a debt counsellor. They would propose a strategy to you that suits your financial condition.
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