B.Between credit cards, student loans, and car loans, it can be difficult to keep track of payments and outstanding debt balances. Consolidating these debts into a single loan can streamline your finances, but the strategy is unlikely to solve the underlying financial challenges. Because of this, it is important to understand the pros and cons of debt consolidation before getting a new loan.
To help you decide whether debt consolidation is the right way to pay off your loans, let’s explain the pros and cons of this popular strategy.
What is Debt Consolidation?
Debt consolidation is the process of paying off multiple debts with a new credit or remaining credit card – often at a lower interest rate.
When consolidating debt with a personal loan, the proceeds are used to repay each individual loan. While some lenders specialized Debt Consolidation Loans, You can use most of the standard personal loans for debt consolidation. Likewise, some lenders pay out loans on behalf of the borrower while others pay out the proceeds so that the borrower can make the payments himself.
With a Credit transfer credit card, qualified borrowers typically get access to an introductory APR of 0% for a period of between six months and two years. The borrower can identify the credit he wants to transfer when opening the card or transfer the credit after the provider has issued the card.
Is Debt Consolidation a Good Idea?
Debt consolidation is usually a good idea for borrowers who have multiple high interest loans. However, this may only be possible if your credit score has improved since you applied for the original credits. If your credit rating isn’t high enough to qualify for a lower interest rate, consolidating your debt may not make sense.
You may also want to think twice about debt consolidation if you haven’t addressed the underlying issues that led to your current debt, such as overspending. Paying off multiple credit cards with a debt consolidation loan is not an excuse to top up your balances and can lead to bigger financial problems down the line.
Benefits of Debt Consolidation
Consolidating your debt can have a number of benefits, including faster, more streamlined payouts and lower interest payments.
1. Optimizes finances
Combining multiple outstanding debts into a single loan reduces the number of payments and interest rates to worry about. Consolidation can also improve your credit score by reducing the chance of a late payment – or a payment default altogether. And as you work towards a debt-free lifestyle, you will have a better idea of when all of your debts will be paid off.
2. Can speed up the payout
If your debt consolidation loan is paying less interest than the individual loans, consider making additional payments with the money you save each month. This can help you pay off the debt sooner and thus save even more interest in the long term. Note, however, that debt consolidation usually results in longer loan terms – so you will need to settle your debts early to take advantage of this.
3. Might lower the interest rate
If your creditworthiness has improved since applying for other loans, you may be able to lower your overall interest rate through debt consolidation – even if you have mostly soft loans. This can save you money over the life of the loan, especially if you are not consolidating with a long loan term. To make sure that you are getting the most competitive rate, do your research and focus on lenders that offer one Prequalification for personal loans Process.
Remember, however, that some types of debt come with higher interest rates than others. For example, credit cards usually have higher tariffs than Student Loans. Consolidating multiple debts with a single personal loan can result in an interest rate that is lower than some of your debts but higher than others. In this case, focus on what you are saving overall.
4. Can reduce the monthly payment
With debt consolidation, your total monthly payment will likely decrease as future payments will be spread over a new and possibly extended repayment term. While this can be beneficial from a monthly budgeting perspective, it does mean that you can pay more over the life of the loan even at a lower interest rate.
5. Can improve creditworthiness
Applying for a new loan can be due to the hard credit request. But debt consolidation can be too Improve your score in different ways. For example, disbursing revolving lines of credit such as credit cards can reduce the credit load shown on your credit report. Ideally, your utilization should be below 30%, and responsible debt consolidation can help you with that. Consistent, on-time payments – and ultimately loan repayment – can also improve your score over time.
Cons of Debt Consolidation
A debt consolidation loan or a credit transfer credit card can seem like a great way to streamline debt settlement. However, there are some risks and disadvantages associated with this strategy.
1. May come with additional costs
Taking out a debt consolidation loan can come with additional fees such as Development fees, Balance transfer fees, closing costs and annual fees. When shopping for a lender, make sure you understand the real cost of any debt consolidation loan before signing on the dotted line.
2. Might Increase Your Interest Rate
If you qualify for a lower interest rate, debt consolidation can be a wise decision. However, if your credit rating is not high enough to access the most competitive rates, you may have to stick to a rate that is higher than your current debt. This may mean paying lending fees plus additional interest over the life of the loan.
3. You can pay more interest over time
Even if your interest rate goes down as you consolidate, you could still pay more interest over the life of the new loan. When you consolidate debt, the repayment period starts from day one and can take up to seven years. Your total monthly payment may be lower than you are used to, but the interest accrues for a longer period of time.
To work around this problem, schedule monthly payments that exceed the minimum loan payment. This way, you can take advantage of a debt consolidation loan while avoiding the additional interest.
4. You risk missing payments
Missing payments on a debt consolidation loan – or any other loan – can cause significant damage to your creditworthiness; you may also incur additional fees. To get around it Check your budget to ensure that you can comfortably cover the new payment. Once you’ve consolidated your debt, you can use Autopay or other tools to help you avoid missed payments. And if you think you might miss out on an upcoming payment, let your lender know asap.
5. Doesn’t solve underlying financial problems
Debt consolidation can make payments easier, but it does not take into account the underlying financial habits that led to that debt in the first place. In fact, many borrowers who use debt consolidation find themselves in deeper debt because they did not curb their spending and kept building up debt. So if you are considering a debt consolidation to pay off multiple maxed credit cards, take the time to develop it first healthy financial habits.
6. May encourage increased spending
Likewise, paying off credit cards and other lines of credit with a debt consolidation loan can create the illusion that you have more money than you actually have. It is easy for borrowers to fall into the trap of paying off debts only to find that their balances have risen again.
Create a budget to cut expenses and keep track of payments so you don’t end up running into more debt than you originally had.
When to Consolidate Your Debt
Debt consolidation can be a wise financial decision under the right circumstances – but it’s not always the best choice. Consider Consolidating Your Debt If You:
- High debts. If you have a small amount of debt that you can pay off in a year or less, debt consolidation is likely not worth the fees and credit checks that come with getting a new loan.
- Additional plans to improve your finances. While some debts cannot be avoided – like medical loans– others are the result of overspending or other financially dangerous behavior. Before you consolidate your debt, evaluate your habits and develop a plan to get a grip on your finances. Otherwise, you may end up with even more debt than you did before the consolidation.
- A credit rating high enough to qualify for a lower interest rate. If your credit score has increased since taking out your other loans, you are more likely to qualify for a debt consolidation rate that is lower than your current rates. This can save you interest over the life of the loan.
- Cash flow that conveniently covers monthly debt servicing. Only consolidate your debt when you have enough income to cover the new monthly payment. While your total monthly payment can go down, consolidating is not a good option if you are currently unable to meet your monthly debt payments.
More from the advisor
The views and opinions expressed herein are those of the author and do not necessarily reflect those of Nasdaq, Inc.