Managing multiple debts with different interest rates and repayment terms can be challenging. For instance, if you are servicing three or four debts and paying monthly instalments for each, you will likely be paying too much interest, and your chances of default will be high as you can be cash-strapped or forget to make a repayment in one month.
One way to bring all those chaos to order, lower the costs of your loans, reduce monthly repayments, and make the repayment more manageable is to consolidate all your debts into one.
Consolidating debt usually involves taking out a new loan in the form of a debt consolidation loan to pay off existing credit. You can use different types of loans to consolidate your debts. But the most ideal one is personal loans.
With a personal loan, you get a fixed amount of money upfront and can use it to consolidate all your debts. You will then pay it back with periodic equal monthly payments until the loan is completely repaid.
In this guide, you will learn more about debt consolidation, how to consolidate all your debts with a personal loan, and what makes them ideal.
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What is Debt Consolidation?
Debt consolidation refers to the process of combining multiple debts into one. Typically, it involves taking one loan, using it to repay your existing loans, and merging payments into one. After rolling the debts together, you will have only one debt with one monthly payment and one interest rate.
Debt consolidation is a debt management solution you can use when you are struggling to repay your loans or have high-interest loans. By consolidating your existing loans into a single loan, you can streamline your finances, reduce debt stress, and potentially save money through lower interest rates and reduced fees.
Imagine the case of Lucy, a 33-year-old pharmacist. Over the last few months, she has been experiencing some financial instability caused by unexpected expenses and delayed salaries. As a result, she accumulated the following debts:
- Logbook loan - Ksh165,600
- Digital Loan - Ksh43,800
- Credit Card Debt - Ksh20,700
- Buy Now, Pay Later Loan (BNPL) - Ksh16,000
The total outstanding debts that Lucy is servicing separately are Ksh246,100. Each month, she makes four different payments on her various debts. She spends Ksh43,000 – half of her salary to service these loans. With the expectation of the buy now, pay later loan, all her debts are high-interest loans which means she’s spending a substantial amount of money paying increasing interest.
Last month, Lucy did a financial check-up and realised her debt was slowly getting out of control, and she needed to act before it was too late. After exploring different strategies to manage her debts, debt consolidation appealed the most to her.
Lucy approached her bank and applied for a Ksh250,000 personal loan. She highlighted that she would use the funds to consolidate her loans in her application. Lucy’s loan request was approved, and she used the borrowed money to clear her debts. Now she has one loan.
In the process, Lucy was able to lower her average interest by one percentile and her monthly repayment by Ksh10,000. While her logbook and BNPL lenders charged her prepayment penalties, her credit score improved, and she can save money in the long run.
Your situation might not be very similar to Lucy’s but if you are thinking about consolidating your debts, a personal loan might be ideal.
Read Also: Top 5 Mistakes to Avoid When Trying to Get Out of Debt
Why Personal Loans Are Ideal For Debt Consolidation
A personal loan, as the name suggests, is money borrowed from a financial or lending institution to be used for personal reasons. One way you can use personal loans is to consolidate your loans. They are ideal for this use case for multiple reasons, including the following:
- Non-restrictive: Personal loans allow you to use borrowed money for various personal and financial reasons, including debt consolidation. Other types of loans, e.g., auto loans, HELB loans, or mortgages, are restrictive and meant to be used for a specific purpose and can’t be used for consolidtion.
- Secured or unsecured: When taking a personal loan to consolidate your debts, you can qualify for one requiring collateral or one that doesn’t. It will typically depend on the lender you choose, the amount you are borrowing, and your overall financial situation.
- Lower interest rates: Personal loans generally come with lower interest rates than other debt types, like credit cards or payday loans. By consolidating your high-interest debts into a single personal loan, you can potentially save money on interest payments and simplify your repayment process.
- Flexible repayment: Personal loans allow you to select a loan term that suits your financial situation. You can choose between shorter or longer repayment periods, and some lenders also provide options for adjusting monthly payments or making extra payments without penalties. This flexibility enables you to customise your repayment schedule based on your budget and financial goals.
- Quick approval: Personal loans often have an easier application and faster approval process than other debt consolidation loans like home equity loans or re-mortgages. With fewer documentation requirements and no need for collateral evaluation, you can receive the funds promptly, allowing you to address your debt consolidation needs quickly.
Read Also: Coping With Debt: How To Deal With Debt of Any Size
How to Consolidate Your Debts With a Personal Loan
Once you have decided to take a personal loan to consolidate your debts, you should follow these steps:
- Gather All Your Debts: Create a spreadsheet or write down and total all the debts you want to consolidate. Include the amount, minimum monthly repayment for each, and their interest rate. This will help you understand how much personal loan you will need.
- Shop Around for Lenders: You can obtain a personal loan from various institutions such as banks, microfinance institutions, Saccos, etc. These lenders typically offer both secured and unsecured loans. Approach multiple lenders and compare their loan terms. Consider starting your search online using Money254's free loan comparison tool to find Kenya's best personal loan lenders.
- Choose Your Lender: Different lenders offer different loan terms and consolidation methods. Some lenders will provide a lump sum to repay all the debts you want to consolidate, while others prefer to pay and deal with your moneylenders directly. Additionally, some lenders may not consolidate certain types of debts you have. It is essential to select a lender that aligns with your needs.
- Consolidate Your Loans: Once you have applied for a personal loan and received approval, use the borrowed amount to repay all the loans you wish to consolidate.
- Begin Repaying Your Personal Loan: After consolidating your debts, assess your financial situation and create a budget to ensure you can comfortably afford the monthly personal loan payments. Consider setting up automatic payments or reminders to avoid missing any payments. Make sure to make your loan payments on time each month, as late or missed payments can result in penalties, additional fees, and a negative impact on your credit score.
Learn More: Full Guide: All You Need to Know About Personal Loans in Kenya
Pros and Cons of Consolidating Debt with a Personal Loan
- Lower interest rate - Personal loans generally have lower interest rates compared to other forms of debt, such as credit card debt or payday loans.
- Lower monthly payments - Consolidating your debts with a personal loan can result in lower monthly payments.
- A clear repayment timeline as one personal loan is easily manageable.
- Simplified payments - Instead of dealing with multiple creditors and due dates, consolidating your debts with a personal loan means you only have to make a single payment each month.
- Faster debt repayment -With a lower interest rate on a personal loan, more of your payment goes toward reducing the principal balance.
- You may incur extra costs such as application and processing fees when applying for personal loans and prepayment penalties when paying off existing debts before maturity.
- Potentially high-interest rates, especially if you have poor credit ratings.
- Some personal loan lenders might require collateral after evaluating you, which might introduce a new risk for you.
Read Also: 5 Reasons Why Taking Loans Won't Stop your Financial Troubles
What to Consider When Choosing to Consolidate Your Debt With A Personal Loan
- Prepayment penalty: Paying your loans off early might attract fines; ensure you talk to your lenders before consolidating loans. Calculate the potential costs and determine if consolidation is a viable option.
- Long-term cost of debt consolidation: Assess the amount of interest you will pay over the extended duration of the debt consolidation loan. While consolidating your debt can reduce your monthly repayments, it may also increase the overall duration of your debt which might increase your loan cost.
- Types of loans eligible for consolidation: Not all loans can be consolidated. Before obtaining a personal loan, ensure that your existing debts are eligible for consolidation. To confirm this, talk to your lenders.
- Explore alternative consolidation loan options: Consider other loan consolidation alternatives besides personal loans. Select the option that best aligns with your specific requirements and financial situation.
Read Also: How to Enjoy a Debt-Free Life in Your 20s
While debt consolidation can be a helpful tool for managing existing debt, it is crucial to recognise that it does not address the root causes of debt, such as overspending and living beyond one's means or a lack of emergency funds. It is crucial to take proactive steps to address these underlying issues to avoid falling into the same debt trap.
As you consolidate your loans, it is imperative to implement strategies to prevent incurring new debt. This includes adopting new financial habits and avoiding unhealthy debt practices. Start by being mindful of your spending and making wise financial choices that can prevent the accumulation of additional debt.
Finally, remember to monitor your progress throughout the debt consolidation process. Stay vigilant in repaying your personal loan in a timely manner, as this will help you avoid further financial difficulties and ensure a smoother path toward becoming debt-free.