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Every time you turn around, you see an ad for debt consolidation. And it seems like a perfect idea.
Who doesn’t love the idea of having one low monthly payment instead of a bunch of extra payments?
And, with the lower interest rate, you’ll save money too! But is debt consolidation the best option for you?
Let’s take a look at some of the pros and cons so you can make an informed decision.f
Table of Contents
What is Debt Consolidation?
Debt consolidation is taking out a new loan to pay off multiple debts. By consolidating debts, you can often get a lower interest rate, which can save you money and help you become debt-free more quickly. Several types of debt consolidation loans include home equity loans, personal loans, and balance transfer credit cards.
Each option has pros and cons, so it’s important to compare your options before choosing a debt consolidation loan.
For example, home equity loans can be a good option if you have equity in your home, but they can also be risky because you could lose your home if you can’t make the payments.
Balance transfer credit cards can be an excellent way to consolidate multiple high-interest debts into one monthly payment, but they typically have high fees and low credit limits.
Personal loans are another option for debt consolidation, but they usually have higher interest rates than home equity loans or balance transfer credit cards.
No matter which type of debt consolidation loan you choose, compare interest rates, fees, and repayment terms before deciding on a loan.
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How to Consolidate Your Debt?
Two main ways to consolidate your debt are with a debt consolidation loan or by transferring your balances to a balance transfer credit card.
If you decide to get a debt consolidation loan, you’ll need to apply for a new loan and use the money from the loan to pay off your other debts. You’ll then be left with one monthly payment, which will be the debt consolidation loan.
If you decide to do a balance transfer, you’ll need to find a credit card with a 0% intro APR period and transfer your balances to the card. You’ll then have one monthly payment: the balance on the credit card.
Both options can help you save money on interest and become debt-free more quickly.
Let’s break down what you need to do before getting a debt consolidation loan or opening a balance transfer credit card:
1. Figure out how much debt you have.
This includes all your credit card debt, student loans, medical debt, and other loans. Anything that you’re in debt on goes into this calculation.
2. Find out the interest rates on each of your debts.
The higher the interest rate, the more it will cost you to pay off your debt. So, you’ll want to focus on consolidating the debts with the highest interest rates first.
3. Review your options.
Now is the time when you need to research your consolidation options. This includes looking at debt consolidation loans, balance transfer credit cards, and personal loans. Compare each option’s interest rates, fees, and repayment terms to find the best one for you.
When is debt consolidation an intelligent move?
Debt consolidation can be smart when it helps you get a lower interest rate, reduce your monthly payments, or pay off your debt faster.
For example, consolidating your debt with a personal loan can save you money if you get a lower interest rate than you’re currently paying on your credit cards, and it can help you become debt-free more quickly if you choose a loan with a shorter term than your current debts.
If you’re struggling to make your monthly payments, consolidating your debt into one payment may make it easier to pay on time each month and avoid late fees.
However, before consolidating your debt, consider whether you can afford the monthly payment on the new loan.
You don’t want to end up in a situation where you can’t make your payments and damage your credit score even further.
If you’re unsure whether consolidation is right for you, talk to a financial advisor to get help assessing your options.
When is debt consolidation not worth it?
Debt consolidation isn’t right for everyone. So, when is it NOT worth consolidating your debt?
If you have a low-interest rate on your current debts, consolidating them into one loan with a higher interest rate doesn’t make sense. You’ll end up paying more in interest overall.
Also, if you’re only consolidating your debt so you can qualify for a lower monthly payment, keep in mind that you’ll end up paying more in interest overall because you’re extending the length of your loan.
So, in the end, you may not save any money, and you could take longer to become debt-free.
Another thing to consider is whether you have the discipline to not use your credit cards after consolidating them. If you consolidate your credit card debt but then continue to use your cards, you’ll end up right back where you started—with a lot of debt and high-interest rates.
If you’re not confident that you can change your spending habits, consolidation may not be the right solution. Likewise, it’s not the best idea to consolidate your debt if you cannot pay it off.
Five key benefits of debt consolidation
Now let’s take a look at the five key benefits of consolidating your debt:
1. One monthly payment
The simplicity of having just one monthly payment can be a huge weight off your shoulders. When you have multiple debts with different interest rates and minimum payments, it can be hard to keep track of everything and make all your payments on time.
With debt consolidation, you have just one payment each month, which can simplify things and help you stay on top of your debt.
2. Lower interest rate
If you qualify for a debt consolidation loan with a lower interest rate than you’re currently paying on your debts, you could save money on interest overall. This is because a lower interest rate means you’ll pay fewer interest charges over the life of the loan.
When you consolidate your debt with a personal loan, you may also be able to choose a shorter loan term, which could help you pay off your debt faster and save on interest charges.
3. Shorter loan term
As we mentioned, when you consolidate your debt with a personal loan, you may be able to choose a shorter loan term. A shorter term means you’ll pay off your debt more quickly, and you could also pay less in interest charges overall.
If you’re consolidating high-interest debt, such as credit card debt, a shorter loan term can help you get out of debt faster.
4. Potential to improve your credit score
If you’re consolidating debt that you’re having trouble paying off, consolidating your debt can help you get back on track.
When you consolidate your debt, you may be able to improve your payment history, which is one of the key factors in your credit score.
A good payment history can help improve your credit score, and a better credit score can mean you qualify for lower interest rates on future loans.
5. Peace of mind
When you’re struggling to pay off multiple debts, consolidating your debt into one manageable payment can be a huge relief.
This can give you the breathing room to get your finances back on track.
If you’re consolidating high-interest debt, such as credit card debt, you may also be able to save money on interest charges. This can give you some extra money each month to put toward other financial goals.
Five key drawbacks of debt consolidation
As with anything, there are also some drawbacks to consolidating your debt. Here are five things to keep in mind before you consolidate your debt:
1. You may pay more in fees.
Fees are those dreaded charges that can add up and eat into your savings.
When you consolidate your debt, you may have to pay fees, such as an origination fee, a balance transfer fee, or a prepayment penalty. These fees can range from 2% to 5% of the loan amount and can add up quickly.
2. You may end up with a higher interest rate.
You may not qualify for the best interest rates if you don’t have good credit. This means you could end up paying more in interest charges over the life of the loan.
The goal is to save money by consolidating your debt, so you’ll want to be sure you’re getting a good interest rate.
3. You may not be able to get a loan for the full amount you owe.
If you have a lot of debt, you may not be able to get a loan for the full amount. Unfortunately, this means you’ll still have some debt after consolidation, which may not be ideal.
The problem is that lenders typically don’t like to lend more money than they think you can afford to repay.
4. You could find yourself paying off the loan more slowly.
If you consolidate your debt into a longer loan term, you may pay off your debt more slowly. This means you’ll pay more interest charges overall.
If you’re consolidating debt to save money on interest, this may not be the best option.
5. You could end up in more debt.
If you consolidate your debt and continue using credit cards or take out loans, you could be in even more debt.
This is because you’ll have more available credit, which can tempt you to spend more. If you’re consolidating your debt to get out of debt, you’ll need to be careful not to run up more debt.
What are the requirements for a debt consolidation loan?
As with anything banking related, there are requirements for a debt consolidation loan. The requirements may vary slightly from lender to lender, but here are some of the most common requirements:
1. A minimum credit score
Most lenders will require a minimum credit score, usually around 640. If you have a lower credit score, you may still be able to qualify for a debt consolidation loan, but you may have to pay a higher interest rate.
2. A minimum income
Most lenders also require a minimum income, usually around $1,500 per month. This is to ensure you can afford the loan payments.
3. A debt-to-income ratio below 50%
Your debt-to-income ratio is the number of your monthly debt payments divided by your monthly income. Most lenders will want a debt-to-income ratio below 50%, which means your monthly debt payments are less than 50% of your income.
4. A home or vehicle to use as collateral
Some lenders will require you to use your home or vehicle as collateral. If you default on the loan, the lender can repossess your home or vehicle.
5. A cosigner
You may need a cosigner for the loan if you don’t have good credit. A cosigner agrees to make the loan payments if you can’t. This could be a family member or friend.
Should I consolidate my debt?
Well, the truth is, it all depends. If you qualify for a low-interest rate and are confident you can make the loan payments, then consolidating your debt could be a good option. Just be sure to do your homework and understand all the requirements and risks before you apply for a loan.
For some of you, debt consolidation might be a good idea, while for others, probably not so much. In the end, it all comes down to your financial situation. The main thing is, if you consolidate your debts, you need to make sure you’re not racking up more debt in the process. Otherwise, you could find yourself in a worse financial situation than before.
If you’re thinking about consolidating your debt, be sure to consider all of these things first. It’s not a decision to be made lightly, but if you research and ensure you’re doing what’s best for your financial situation, it could be a good way to get out of debt and improve your credit score.
The main thing to remember is that debt consolidation is not a cure-all solution. It can help you get out of debt and improve your credit score, but it will not fix all your financial problems. Some people think that consolidating their debt means they’re getting a “fresh start.” This is not the case. You’re still responsible for all your debt, and if you don’t change your spending habits, you could find yourself in the same situation as before, just with a new loan.
Any time you’re considering taking out a loan, it’s essential to do your research and make sure you understand all the terms and conditions. This is especially true for debt consolidation loans. Be sure to shop around and compare offers from different lenders before you decide on a loan.
You should also make sure you understand the fees associated with the loan. For example, some lenders may charge origination fees, application fees, or other charges. These fees can add up, so be sure to factor them into your decision.
Another thing to consider is the repayment term. Some loans may have shorter terms, which could mean higher monthly payments. Others may have longer terms, which could mean lower monthly payments but more interest paid over the life of the loan.
Finally, be sure to consider the interest rate. A lower interest rate could save you money over the life of the loan, but a higher interest rate could mean you pay more interest.
These are just some of the things to consider when you’re thinking about consolidating your debt. Be sure to do your research and make sure you’re getting the best deal for your situation.
Disclaimer:
We hope the information in this article provides valuable insights to every reader but we, the Biesingers, are not financial advisors. When making your personal finance decisions, research multiple sources and/or receive advice from a licensed professional. As always, we wish you the best in your pursuit of financial independence!
