Legal Definitions - consolidation loan

A consolidation loan is a new loan taken out to pay off multiple existing debts. The primary purpose is to combine several smaller debts into a single, larger loan, often with the aim of simplifying payments, securing a lower overall interest rate, or extending the repayment period.

Here are some examples to illustrate how a consolidation loan works:

• Example 1: Credit Card Debt

  Sarah has three different credit cards, each with a balance of $5,000 and varying high interest rates (18%, 22%, and 25%). Juggling three separate payments each month is stressful, and the high interest means she's paying a lot more over time. Sarah decides to apply for a personal consolidation loan of $15,000 from her bank. If approved, the bank will disburse the funds, which Sarah will then use to pay off all three credit card balances in full. Now, instead of three separate credit card payments, she has one single monthly payment to the bank for the consolidation loan, potentially at a lower, fixed interest rate of 12%. This simplifies her finances and could save her money on interest.

  This illustrates a consolidation loan because Sarah takes out one new loan to eliminate multiple existing, high-interest debts, streamlining her repayment process.

• Example 2: Diverse Personal Debts

  Mark has several financial obligations: a personal loan for home improvements, an outstanding medical bill, and a small car loan. Each has a different due date, interest rate, and minimum payment amount. Feeling overwhelmed by managing these separate accounts, Mark explores options to simplify. He applies for a home equity consolidation loan, using the equity in his house as collateral. Upon approval, he receives a lump sum that he uses to pay off the home improvement loan, the medical bill, and the car loan. Now, he only has one monthly payment to make on his home equity loan, which typically comes with a lower interest rate than unsecured personal loans or medical bills, and a longer repayment term.

  This demonstrates a consolidation loan because Mark uses a single new loan (secured by his home) to combine and pay off various distinct debts, simplifying his financial obligations into one manageable payment.