The application for personal loans has been on the rise in Singapore. This could be attributed to rising inflation, the high cost of living, or the lingering effects of the Covid-19 pandemic.
These factors have also raised the use of credit card services for daily expenses. While these loans are vital in meeting the shortfall of cash, they can put borrowers in an endless debt cycle.
Besides, getting a loan from a bank or a financial institution can be daunting, especially to those unfamiliar with finance.
You may have heard of different types of loans, all serving different purposes. In this guide, we’ll focus on the difference between debt consolidation and personal loans and answer the question: “Which is better, debt consolidation or personal loan?” Read on.
What Is A Debt Consolidation Loan?
A debt consolidation loan can be referred to as a personal loan used to pay down other debts. As the name suggests, you’re consolidating multiple debts into one to lower the interest rates.
You can also use other loan types to consolidate debts, like a home equity loan, a home equity line of credit, or a personal line of credit.
Making several payments to different lenders every month can be a hassle and expensive. This is because a consolidated loan has a lower interest rate than the multiple rates on the loans you owe.
How Debt Consolidation Loan Works
As mentioned above, a debt consolidation loan is best when you have several high-interest debts. The move helps keep track of your monthly payment and lowers interest rates. Below is how the loan works:
- Apply for a personal loan to cover all the current debts
- Once approved, use the cash to pay off the debts, prioritizing the loans with the high-interest rates
- Afterward, make a single monthly payment
- Pay off the new loan over the agreed loan conditions and terms to avoid the late payment penalties.
A debt consolidation loan helps you save money in the long run and have a more definite time of clearing off several debts.
Debt Consolidation Loan Vs Personal Loan
A debt consolidation loan is a personal loan type you take from a bank specifically for debt consolidation.
You use the loan to combine all your existing debts into a single loan, and it can help manage your monthly payment and lower the interest rates. On the contrary, a personal loan is a loan you borrow from a bank or other financial institutions for various purposes, including debt consolidation.
You can use a personal loan for virtually anything. Still, it’s advisable to make better use of such as debt consolidation. You can access a personal loan within a few days and take care of your emergencies if you don’t have an emergency fund.
Generally, avoid using a personal loan for consumer purchases if the payments make it harder to afford your other bills.
The increased debt could raise your debt-to-income ratio making it expensive or harder to get another loan.
Pros And Cons Of A Debt Consolidation Loan Vs Personal Loan
A Singapore debt consolidation loan can have several advantages, including reduced interest payments and a faster, more streamlined payoff.
Pros Of Debt Consolidation
Reduced Interest Rate
Suppose you’ve raised your credit score since applying for other loans. You can decrease your overall interest rate by consolidating debts, even with low-interest loans.
Consolidating your debts can save you money over the loan term, especially when you consolidate with a short loan term. Always work with lenders offering a personal loan prequalification process for the most competitive rates.
If the debt consolidation loan is attracting less interest than the individual loans would, you can make extra payments with the money you’re saving every month.
This allows you to pay off your debt quicker, saving even more on the interest in the long run. However, remember that debt consolidation usually leads to an increased loan term.
Therefore, ensure you pay off your debt early to leverage this benefit.
Streamline Your Finances
Consolidating multiple debts into a single loan will reduce the interest rates and the number of payments. This also helps improve your credit by lowering the chances of a late payment or missing the payment completely. Debt consolidation also lets you know when you’ll pay off your debt.
Lower Monthly Payment
Debt consolidation decreases your overall monthly payment since future payments are spread out over an extended and new loan term. While this can benefit from the monthly budgeting point of view, it implies that you might pay more over the loan term, even with a reduced interest rate.
Improve Credit Score
Applying for a new loan could lead to a temporary dip in your credit score due to the hard credit inquiry. However, a debt consolidation plan can improve your credit score in several ways. For instance, paying off revolving lines of credit, such as credit cards, can lower the credit utilization rate reflected in your credit report.
Your utilization rate should be less than 30%, and consolidating debt responsibly can help you achieve that. Making timely and consistent payments can help improve your credit score over time.
Cons Of Debt Consolidation
Despite the many advantages of a debt consolidation plan, there are some cons and risks associated with the strategy.
May Bring Added Costs
Borrowing a debt consolidation plan may come with extra fees such as origination fees, closing costs, annual fees, and balance transfer fees. Therefore, when shopping for a lender in Singapore, ensure you understand the real cost of every debt consolidation loan before taking it out.
Could Increase Your Interest Rate
Dent consolidation can be wise if you qualify for a lower interest rate. However, if you have a low credit score to help you qualify for the most competitive rates, you could be stuck with an interest rate higher than on the current debts. This could imply paying origination fees plus higher interest over the loan’s term.
You Could Pay More In Interest Over Time
Even with the reduced rates when consolidating your debts, you might still pay more in interest over the new loan term. A debt consolidation plan permits you to pay the loan from day one and could extend it for as long as seven years. The overall monthly payment may be lower than you’re accustomed to, but the interest accrues for an extended period.
To avoid this issue, it’s advisable to budget from monthly payments exceeding the minimum loan payment. Doing so will allow you to leverage the advantages of a debt consolidation loan as you avoid the extra interest.
You Risk Missing Payments
A missed payment on a debt consolidation loan can significantly damage your credit score, which may also attract added fees. To avoid such a situation, always review your budget to ensure you can comfortably pay off the current loan.
After consolidating your debts, always use the autopay feature and other tools that help avoid missed payments. If, in any instance, you think you could miss an upcoming payment, always liaise with your lender as soon as possible.
Doesn’t Take Care Of The Underlying Financial Problems
Debt consolidation in Singapore can simplify your payments, but it doesn’t solve the underlying financial habits or problems that contributed to the debts in the first place. In some instances, many borrowers who take out a debt consolidation loan find themselves deeper into debt because they didn’t solve their spending habits and continued building debt. Always fix your financial habits the first time you plan on debt consolidation to pay off several maxed-out credit cards.
May Encourage Increased Spending
Repaying credit cards and other lines of credit with a debt consolidation plan could create the illusion that you have more money than you do. You could easily fall into the trap of paying off debts only to find that your balances have increased. So, set a budget to reduce spending and stay up-to-date with your payments to avoid raising more debt than you initially had.
What Is A Debt Consolidation Plan?
A debt consolidation plan is a debt refinance program offering a borrower the option to consolidate all the unsecured credit facilities across financial institutions with one participating financial institution.
Certain unsecured loans, such as renovation loans, joint accounts, medical loans, and renovation loans, are excluded from a debt consolidation plan.
Choose The Best Loan For Your Needs
A debt consolidation loan can be referred to as a personal loan used to pay down other debts.
As the name suggests, you’re consolidating multiple debts into one to lower the interest rates. You can also use other loan types to consolidate debts, like a home equity loan, home equity line of credit, or personal line of credit.
Making several payments to different lenders every month can be a hassle and expensive. CreditMaster is your best bet for more information about personal and debt consolidation loans.