If you are struggling financially, debt consolidation is one way that you can get a grip on your finances. But debt consolidation isn’t a magic process that erases your debt, and in some instances it might actually put you in more debt. So how does debt consolidation work and how do you know if it’s a good move for you?
Debt consolidation is when you have multiple debts across different accounts that you combine into one single account. There are three types of debt that you can consolidate: credit card debt, student loan debt and high-interest personal loan debt. These three types of debt can very easily get out of hand and when you have debts across many different accounts it is easy to get overwhelmed. But consolidating your debt will simplify your payments and possibly save you money.
Debt consolidation can be beneficial for quite a few reasons. First and foremost it will simplify your life. If you have several credit card debts, they all have their own payment due date, minimum payments, interest accruals, and late payments. This means that every month you have a lot to juggle and a lot of minimum payments to make. You are always one missed payment away from an increased interest rate or a late fee. But if you can move all of these debts to one account you will only have to worry about one due date and one minimum payment. This can make your life much easier and make your finances much easier to manage.
When you have several accounts, chances are that a few of them have high interest rates. But when you consolidate your debt you will consolidate them into one account with one interest rate, and there's a good chance that it can save you money on those high interest accounts.
Your credit score takes a lot of factors into consideration and there are many things that can cause your credit score to dip when you have debts across a lot of accounts. When you have a lot of accounts you are much more likely to miss a payment, make a late payment, or make an incomplete payment. All of these things can cause your credit score to take a hit. But if you consolidate your debts you will have a much better chance of keeping up with your payments and helping your credit score.
While there are many benefits to debt consolidation, there are a few drawbacks that you may need to consider.
Depending on how you consolidate your debt there might be some upfront fees that you are required to pay. Loan origination fees and balance transfer fees can both eat into any savings that you might make by consolidating.
If you take out a secured loan, such as a home equity loan, you can put yourself in serious financial risk. If you fall behind on payments you could even lose your home.
If you are having trouble every month keeping up with payments, consolidation can help you to extend your repayment periods. This will help to keep your monthly payments low so that you can keep your head above water, but this also may result in paying more interest over the life of your loan.
When it comes to consolidation, there are several different ways you can consolidate your debt, each with their own pros and cons.
One way to consolidate your credit card debt yourself is to transfer all of your debt to a low interest credit card. You can transfer your balances yourself and pay a balance transfer fee. After that your debt will be located under one account (and only have one payment).
The pros: You can easily do this yourself and find a credit card that has a low (or no) interest promotional balance transfer rate.
The cons: The promotional rates usually have an expiration date and you will then be required to pay the full rate. If you are late on a payment the bank may increase your rate and you will end up in more debt than you were in before.
Many banks, credit unions, and installment lenders offer specific loans that are designed for debt consolidation. When you take out a consolidation loan your lender will pay off your debts on your behalf and you will pay your new lender for the new combined debts.
The pros: You can shop around to get a good consolidation rate that may be less than some of your other accounts.
The cons: There is a good chance you will pay more over the life of your loan. Your repayment period will extend so that your monthly payments are affordable, but this means that you will pay interest over a longer period of time.
If you own a home you can actually borrow against the equity in your home. You can use this money to pay off your debts, and then you will make payments back to your mortgage company.
The pros: Home equity loans usually have lower interest rates than other loans out on the market.
The cons: If you fail to make payments on your home equity loan you can actually lose your house. It is a risky way to borrow money if you are in a tight financial situation.
If you have a retirement account set up such as a 401(k) you may be able to borrow against your retirement account to consolidate your debts. You are typically allowed to borrow the greater of $10,000 or 50% of your account balance, or $50,000, whichever is less.
The pros: There is no credit check involved and any interest that you pay on your loan goes back into your account.
The cons: If you leave your job you may be required to pay back the money by the following tax season and face penalties if you cannot. You will also miss out on any gains that you may have been entitled to during that time.
If you are struggling and it feels like you are in over your head, a debt management plan might be the answer for you. These plans are created by non profit companies that will help you organize your finances and get on a payment plan that works for you.
The pros: You can get professional help to navigate your debt repayment. They will help you to negotiate rates and help eliminate fees that you otherwise might be required to pay.
The cons: You may be required to close some of your credit card accounts as a stipulation. This can cause your credit score to dip and can affect your finances in the future.
Debt consolidation is a good option if you have good credit, have a lot of high interest debt, and you have a plan for the future. If you have good credit you will be able to secure a reasonable debt consolidation interest rate and will most likely be able to reduce the high interest rate you are currently paying. But it’s important that you have a plan for the future. You want to ensure that you can pay off your consolidation loan, avoid accumulating new debt, and continue paying your other bills and obligations. A well thought out budget will help you to achieve this. You can look for other opportunities to reduce your monthly payments, such as refinancing your car loan.
Debt consolidation might not be a great option if you have a bad credit score and/or do not have a lot of debt. A bad credit score means you may not get a good interest rate, and if you are only in a small amount of debt you will likely not see a lot of benefits in consolidation.
Debt consolidation is a great option for many people who find themselves struggling to keep up with payments every month. Consolidating can help you to simplify your payments and reduce the amount you owe every month.
Refinancing your car loan is another great way you can help to reduce the amount you are paying every month. If you have a car loan, contact Auto Approve today. Our experts can help you determine if refinancing is right for you (and show you just how much money you could be saving!)