Consolidation makes sense? How to proceed? We clarify!
Increasingly, more and more people are realizing the benefits of consolidation and are therefore considering giving up existing loans. A lower interest burden, a better overview of their own finances and an improvement in creditworthiness are reasons that speak for the repayment of loans.
Even if loans were once cheap, this step can be worthwhile. In a low-interest phase may lure a full savings.
1. Debt consolidation – what exactly is that?
The term debt consolidation means the repayment of a loan by another loan that is specifically taken for this purpose. You do not have to limit yourself to a loan. It is also possible to replace several loans and combine them in a new loan.
Each loan remubber always runs according to the same pattern. The first step is to determine whether debt consolidation is possible at all, ie the borrower must be entitled to repay his existing loan early. If this option is given, the second step is to determine whether a suitable loan is available. Then follows the borrowing to then use the loan amount to replace the old loan. The remaining debt is repaid, so shortly thereafter, only the new loan exists.
2. When is consolidation useful?
The aim of consolidation is to improve the borrower’s financial position. Which exact goals are pursued here is different. The following is an overview of the main consolidation reasons.
- Use interest advantage: Perhaps the borrower was once bad advice or he has completed his loan in times of high interest rates. Insofar as it is possible to repay the remaining debt and finance it at a lower interest rate, a lavish saving is attractive. It makes it possible to reduce the repayment term or reduce the monthly installment charges.
- Gain a better overview: Another consolidation reason is the chance to jointly repay several loans and combine them into just one loan. This makes it easier to keep track of your own credit obligations.
- Correct the repayment term: It sometimes happens that borrowers choose an inappropriate term and want to correct it. Because the maturity of the existing loan can not usually be adjusted, only the debt consolidation loan offers the opportunity to make a correction.
- Improve creditworthiness: It is not bad at all if only an installment loan or similar financing exists. It has almost no effect on credit quality, so that nothing stands in the way of mortgage lending or a similar financing project. The situation is different if there are several loan liabilities. The combination of all loans helps to improve the credit rating.
2.1 Example: Calculating the savings of a consolidation of multiple loans
The summary of multiple loans in just one loan not only promises a better overview, but also the chance of a lower interest burden. However, many people can not immediately tell if this applies to their case as well. By means of an example, we would like to clarify which savings lure in the case of a consolidation and how they can be calculated.
There are the following 3 credits
- Car loan over 15,000 euros with a term of 5 years and a loan installment of 283.07 euros
- Residential loan over 9,000 euros with a term of 8 years and a loan installment of 129.53 euros
- Consumer loan over 4,000 euros with a term of 3 years and a loan installment of 121.69 euros
For a better understanding, we assume that no repayments have been made and no prepayment penalty has been paid. Thus, it would be necessary to reclassify a total amount of € 28,000.
With our loan calculator, we have determined the following financing offer, which offers itself for the planned consolidation.
The term was set at five years, because it results in a rate slightly below the sum of the old installments. While the old constellation provided for a loan to be repaid for as long as eight years, the borrower is now completely debt-free after just five years.
The total interest cost previously amounted to 5,799.71 euros. Now they are only 3,068.84 euros, resulting in a saving of 2,730.87 euros.
2.2 The prepayment penalty – is a consolidation still worth it?
The replacement of an existing loan before the end of the term is in most cases easily possible. However, it can not always be done free of charge. Because banks incur a loss of interest income and they usually refinance their loans themselves, they are entitled to charge a fee. This fee is called prepayment penalty.
If a prepayment penalty is payable, it must be taken into account in the context of your own calculation. It has to be examined whether the debt consolidation is still worthwhile. The amount of compensation that the bank demands depends on what type of loan is involved and when it has been closed.
In addition, the situation on the interest rate market can play an important role. If the market interest rates have fallen, the bank threatens an additional interest loss when creating the prematurely refunded loan amount. Therefore, it is advisable to calculate the expected compensation amount from the bank and to have it confirmed in writing.
High costs usually threaten with the early repayment of real estate loans. For installment loans, the prepayment penalty is usually limited to a lump sum of a maximum of one percent of the remaining debt. Details can be found under point 7.
In the above example, a residual debt of 28,000 euros was determined. Due to the general conditions (time of conclusion, type of loan, etc.), we accept a prepayment penalty amounting to one percent of the remaining debt.
Prepayment Penalty: 28,000 euros * 1% = 280
As a result, the savings would be reduced by debt consolidation from 2,730.87 euros to 2,450.87 euros. However, this amount is still so large that it is still advisable to repatriate the loans.
1. What is decisive in the consolidation? What should I pay particular attention to?
It is not enough to understand the process of debt consolidation. The decisive factor is the actual examination as to whether it is worth taking a debt consolidation loan. The following tips clarify what is important.
Take into account the annual percentage rate of charge : The calculation of the exact interest burden as well as the total cost of financing is not easy for everyone. For a quick comparison it is advisable to compare the effective annual interest rates of the individual loans. They take into account not only interest costs, but also ancillary costs. Thus, it can be seen at a glance whether a new loan promises an interest rate advantage.
Determine savings correctly: Should a prepayment penalty be payable, the interest savings will be reduced. In such a situation it is essential to know the exact amount of the compensation and deduct it from the savings. This is the only way to know if there will be a financial benefit in the end.
Even if a zero-sum game threatens, ie the planned consolidation does not seem to bring either a financial advantage or disadvantage, the other advantages are not to be ignored. A better overview of private credit and a better credit rating, as there are no longer several loans at the same time, can still speak in favor of debt consolidation.
4. What are the possibilities of debt consolidation?
There are two options for debt consolidation. However, they do not differ as to how the actual consolidation takes place, but what loans are taken for it.
With a special debt consolidation loan:
In this case, a special debt consolidation loan will be taken out, ie it will be subject to a purpose limitation. Therefore, the loan amount is not even paid to the borrower. Instead, it flows directly to the banks, whose loans are to be replaced. The advantage of such a loan is that it is easier to get. If several credit obligations already exist, many banks could decide against lending. This is different for a debt consolidation loan because it does not increase the borrower’s monthly charge.
Early redemption with a loan for “free use”:
A loan is taken out which is not subject to any purpose limitation. The loan amount is paid to the current account of the borrower, so that he independently repays the existing loans. Depending on the credit rating, this variant can be more difficult. Nevertheless, it is not automatically worse. In this segment, the choice of loans is greater, so that with less luck lure even better interest rates.