Personal loans: What is a loan consolidation, and why should you opt for it?

Have you heard of the phenomenon of clearing off a personal loan by raising a fresh one? Or did you ever think of someone contemplating raising a new loan to clear off his myriad old debts? This is neither unusual not irrational. Let us explain why.

Suppose Mr Z has five different loan obligations from as many banks across durations. These are the loans he took over a period of time. Different loans carry different interest rates – 11 percent, 11.5 percent, 12 percent, 12 percent and 12.3 percent. Now, suppose one of the five banks is willing to offer a top up on his loans and this top-up amount is large enough to pay back all his current liabilities.

And icing on the cake is that the new loan bears an interest rate of 11 percent per annum. Anyone in his right mind would advise him to grab this opportunity. Isn’t it?

What is loan consolidation?

It is the process of merging multiple loans into a single loan, usually with one monthly payment and potentially at a lower interest rate or a longer repayment tenure. Loan consolidation is commonly used for student loans but can apply to other liabilities as well such as credit cards and personal loans.

Why should one opt for it?

There could be three different reasons for opting for it:

i) The fresh loan is typically given on favourable terms and conditions.

ii) The tenure of new loan starts afresh which means longer tenure vis-a-vis previous loans and smaller EMIs.

iii) It is convenient to deal with one loan with one EMI and one date to remember in comarison to multiple loans with as many dates of instalments.

What are the things to be careful about?

There are a few things to be careful about. These are as follows:

i) Borrower must make sure that there are no hidden charges in the new loan.

ii) Another important factor to consider is that savings on interest outweigh the processing charges of the new loan. Else, it does not make sense to raise a fresh loan when the additional cost of raising it offset the savings.

iii) Last but not the least the lender’s reputation is reasonable good in the market. Institutions with bad reputation generally have bad customer service and in case of some problem with regards to extra charges – you should be able to coordinate with the customer care.

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