The term Debt consolidation is a form of debt refinancing that has to do with taking out one loan to pay off many others. Plainly, it refers to a personal finance process of individuals addressing high consumer debt. However, it is occasionally referred to as a country’s fiscal approach to corporate debt or Government debt. It is one pertinent process that can secure a lower overall interest rate to the entire debt load and help to provide the convenience of servicing only one loan.
Indeed, debt commonly refers to money owed by one party, who is referred to as the debtor, to a second party, the creditor. A debt is normally subject to repayments of principal and interest.
What is ‘’Interest’’? Interest, literally, is the fee charged by the creditor to the debtor. It is generally calculated as a percentage of the principal sum per year known as an interest rate. Worthy of note is that, it is generally paid periodically at intervals, such as monthly or yearly. Another thing to note is that a ‘’Debt’’ can be secured with collateral or unsecured.
Even though, there is disparity or better still, variation from country to country, and even in regions within country, consumer debt is primarily made up of home loans, credit card debt and car loans. Meanwhile, household debt is that kind of consumer debt basically concerned with adults in the household plus the mortgage, if relevant.
Suffice it to say that in many countries, especially the United States and the United Kingdom, student loans can be a significant portion of debt. However, they are usually regulated differently than other debt. While the overall debt can reach the point where a debtor is in danger of bankruptcy, insolvency, or other fiscal emergency, the options available to overburdened debtors include (but not limited to) credit counseling and personal bankruptcy.
Other vital consumer options available include:
- Debt Settlement: this is where an individual’s debt is negotiated to a smaller interest rate or principal, with the creditors to lessen the overall burden;
- Debt Relief: this is where part or whole of an individual debt is forgiven; and the last?
- Debt Consolidation: this is where the individual is able to clear the current debts by taking out a new loan.
But sometimes the solution may include some or each of these tactics:-
- The immensity of the consumer debt especially that with a high interest is repaid by a fresh new loan: There is need to state that most debt consolidation loans are offered from lending institutions and secured as a second mortgage or home equity line of credit. These require that the individual put up his/her home as collateral and the loan to/must be less than the equity accessible.
- The overall lesser interest rate is an advantage that the debt consolidation loan offers consumers: In this case, lenders have fixed costs to process payments and repayment can spread out over a larger period. However, such consolidation loans have costs: fees, interest, and “points” where one point equals to one percent of the amount borrowed. Furthermore, in some countries, these loans may provide certain tax advantages or merits. Because they are secured and legally-bounded, a lender can attempt to seize property if the borrower goes into default or breach the terms of agreements.
- Personal loans comprise another form of debt consolidation loan: As a matter of fact, individuals can issue debtors a personal loan that satisfies the outstanding debt. And also, a personal loan which creates a new one on their own terms. These loans, often unsecured and not-legally contracted, are based on the personal relationship rather than collateral.
Student loan consolidation: What it entails…
It is germane to state clearly that in the United States, federal student loans are consolidated, and somewhat different from that of the UK. This is because, they (the federal student loans) are guaranteed by the U.S. government.
The Way it Works in the United States
In a federal student loan consolidation, existing loans are purchased by the Department of Education. And upon consolidation, a fixed interest rate is set. But this must be based on the then-current interest rate. In fact, reconsolidating does not change that rate. If the student combines loans of different types and rates into one new consolidation loan, a weighted average calculation will establish the appropriate rate. And it is based on the then-current interest rates of the different type of loans being consolidated together.
In furtherance, federal student loan consolidation is often referred to as refinancing. But it is incorrect, because the loan rates are not changed, it is just merely locked in. Unlike private sector debt consolidation, student loan consolidation does not incur any fees for the borrower. On the contrary, private companies make profit on student loan consolidation by reaping subsidies from the federal government.
In the United Kingdom
In the UK student loan entitlements are not only guaranteed, but are also recovered using a means-tested system from the students’ future income. Categorically, student Loans in the UK cannot be included in Bankruptcy, because it does not affect a person’s credit rating. This is because the repayments are recovered from students’ future salary at source by the employer before any income is paid. It is similar to Income Tax and National Insurance contributions. But sadly, many students however, are struggling with commercial, non-student loan debt, long after their courses have finished.
The Australian Experience
Hitherto, Australia’s student loan system had 35 years to pay back loans, but it’s currently fifteen (15). The seriously delinquent student who wants to evade paying back their loans risk being arrested at the border.
How it Works in Japan
It is an obvious fact that in Japan, an increasing number of student loans are in arrears. And this has caused the Asian nation to take harsher steps when it comes to lending determinations. It is needless to say that in an effort to prevent future defaults, Japan has begun associating loan approvals to academic performance.