Debt Consolidation
Debt Consolidation is a loan product which helps in consolidating many loans into a single loan. It is a powerful tool to reduce various high cost and short term loans. Many businessmen overleveraged themselves by availing high cost unsecured loans which are generally short term in nature. Any adverse market conditions would put extreme pressure on the business and increases the chances of default in loans. Debt consolidation gives a lot of breather to businesses since it reduces the installment outflow to a larger extend, the loan being a long term and low cost one and also it helps in expanding their operations. Such type of loan comes with a security mostly property, investments, stocks or book debts or a combination of all. Banks have devised many product variants under debt consolidation and offer these products in isolation or a combination of products.
The most prominent products under debt consolidation are as follows:
- Loans Against Property
- Cash Credit
- Overdraft
- Term Loan
Cash Credit
Cash credit is a facility which operates in a manner different than that of various other loans. Cash credit comes with a limit and it helps in the smooth conduct of business. It also helps in reducing the asset liability mismatch. Cash credit limit is sanctioned for a specific period of time, usually a year. The entity to which the limit has been sanctioned can use the cash credit at any point during the time period and the specified rate of interest will be charged on the amount that is taken or used. It can be operated like any other account. It means withdrawing money when there is a need and then depositing back the payments received from parties.
Once the time period for the cash credit limit is over, the limit has to be renewed. Also limit can be enhanced if the business is in expansion mode. The rate of interest on cash credit depends on the market conditions as well as the behavior of the borrower over the last time period when he/she operated this facility.
Cash Credit also helps in bridging the gap of current assets and current liabilities. Typically such requirement to bridge the gap is also known as working capital requirements.
Any business activity is not conducted solely in cash but it also requires credit facilities. This means that every purchase or sale does not result in immediate payment, rather in most cases the cash will come after some point of time. Sales on credit will result in debtors while other receivables will give rise to an asset that will be received in the future. Similarly, when a purchase is made there will be creditors, and there might be some payments that a business has to make which will result in an outstanding. This along with the amount locked in stock and raw materials will make up the working capital requirement for a business.
There is a specific amount that will be locked up in stock and raw materials till the time the entire cycle is set wherein the various payments start coming in, and on the other side, the payments required to be made are also done. This amount varies across businesses, resulting in different working capital requirements.
Overdraft
Many a time it is not possible to raise loans during an emergency for funds in business. Under such circumstances the investments in the form of Fixed Deposits, Govt of India Bonds, and Debt funds can help in raising funds without much difficulty. Here, an investor can earn returns on his/her investment just like a normal investment and at the same time use this investment as a means to raise funds that can be used for the business.
An overdraft facility calls for using some investment of the borrower as a security and then providing a facility to borrow against this amount. There is a specific amount that is allowed as the borrowing. The security earns the normal rate of return for the investor and at the same time provides additional finance facility. The good part of the entire exercise is that the borrowers will pay interest only for the time period for which they have borrowed the amount and that too for the specific amount for which they have overdrawn the account.
Term Loans
Term loans are one of the traditional and most common routes used by entities to raise funds. These funds are then used for the business in various ways. One big area of lending in case of term loans is the loans given to small-scale enterprises and businesses that are typically run by individuals or even firms and companies. Term loans form a significant part of the lending process of an entity and this is the reason why it requires attention.
What distinguishes term loans from other borrowings is its tenure. Various other loan options available are short term where the time period is usually around a year and has to be renewed thereafter. But term loans have slightly longer time period.
Most banks in the country provide term loans, so it is not difficult to obtain this type of loan. The conditions and other factors related to the loan will change and there might be some specific sub-category under which the loan will be given by a specific bank, so these factors have to be distinguished while selecting a lending bank or institution. Having a good relationship with the bank will help a borrower while taking this loan, so one should approach a bank with which he/she shares a high comfort level.
There are various purposes for which a bank will provide a term loan. There is a list of reasons why this is done and the borrower has to ensure that the reason that they seek a loan for is one of it. Some of the common reasons listed by the banks include:
- To setup plant & machinery
- To reduce high cost of borrowings
- To build assets for a business
- To help grow a business through strategic investments
- To strengthen the asset base
A borrower has to provide the necessary details and documents in support of the claim and then he/she will become eligible for the term loan.
FAQs:
Quite simply, debt consolidation is taking all or most of your outstanding debt and combining that into one payment. This can be done in a variety of ways including home equity loans, secured loans, and unsecured loans. Secured debt consolidation loans, secured by assets the borrower may own are typically the easiest form of loan to qualify for. Of course the lender will ask you to put up collateral for that loan in the form of property or anything of value that could cover the loan should you default.
Why would I want to consolidate my debts?
Consolidation can increase your disposable income by reducing your monthly repayments. It can also make your life a lot simpler. The more debts you have, the harder it is to keep track of them – and making payments late (or missing them altogether) can affect your credit rating and lead to charges, higher interest rates, or even legal problems.
How can debt consolidation lower my monthly payments?
First, you can arrange to pay back the debt over a longer period of time. Since you're paying it back more slowly, each monthly payment will be lower. However, since you'll owe money for longer, you'll be paying interest for longer, and that could mean you'll end up paying more in the long run. Second, many unsecured loans especially personal loans and credit cards come with high interest rates. If you can find a consolidation loan with a lower interest rate, this can also reduce your monthly payments, depending on how quickly you're paying off the consolidation loan.
What are the advantages of Debt Consolidation?
These loans can help you salvage your credit standing before it is too late.
With a bit of collateral these loans can be easy to qualify for.
You will likely be able to avoid bankruptcy
All payments are consolidated to one monthly EMI
What are the potential pitfalls Of Consolidating?
If you default on the loan, your pledged assets will go to the lender to pay your debt off. Typically the time frame to totally pay off your loan will be extended pretty substantially. You will likely end up paying more in interest by the time it is all over.
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