As of the second quarter of 2022, Americans owed a total of $16.5 trillion in debt, including mortgages, car loans, credit cards, and student loans. This figure represents a significant increase from previous years, and many Americans struggle to keep up with their payments. Some have even been forced to explore other options, such as debt consolidation or refinancing, to manage their growing debt burden.
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A few options are available to those trying to overcome their debt. One option is to work with creditors to settle the outstanding debt. Another option is to use a home equity line of credit or get a debt consolidation loan.
Debt consolidation is the process of combining multiple debts into one new loan. This can be beneficial as it allows the person to streamline their monthly debt payments into one single charge, and in many cases, at a lower interest rate. There are both advantages and disadvantages to debt consolidation. On the one hand, it could simplify your finances and help you repay your debt sooner. On the other hand, there may be some upfront costs associated with consolidating your debt.
Here’s how debt consolidation works
Debt consolidation can be a great way to save money and get out of debt. By combining two or more debts into a larger one, you can often get a lower interest rate and save money on monthly payments.
This can be helpful for people who have several different debts, such as credit card debt, auto loans, student loans, or medical debt. With debt consolidation, the borrower only has to make one monthly payment instead of separate fees for each debt. This can make managing debts much easier and more affordable for many people.
By consolidating your debts into one loan with a lower interest rate, you can save hundreds or even thousands of dollars over the life of the loan.
Consolidating debt has 5 benefits
Debt consolidation can help you get out of debt and improve your financial situation. Here are some of the main benefits that may apply:
1. Repayment of debt more quickly
Debt consolidation loans can help you pay off your debt faster, especially if you have a lot of credit card debt. With a consolidation loan, you have fixed monthly payments and a clear timeline for paying off the loan. This can be helpful compared to credit cards, which don’t have a set timeline for repayment.
The quicker you pay off your debt, the less interest you will have to pay in the long run. Additionally, debt-free frees up more money that can be put towards other financial goals, such as building an emergency fund or saving for retirement.
2. Simplified finances
Instead of making multiple payments to different creditors, you can make just one payment each month. This can help you better manage your money and avoid missing payments. Plus, with a fixed monthly fee, you’ll always know exactly how much you need to set aside.
When you consolidate your debts, you take out a new loan to pay off your debts. This can often lead to lower interest rates and monthly payments, making it easier to get on top of your finances.
3. Rates of interest are lower
The average credit card rate is 18 percent, while the average personal loan rate is 11 percent. However, depending on your credit score and loan amount, you can get a lower interest rate with a debt consolidation loan. This could help you save money in the long run.
Debt consolidation loans can be a great way to save money on interest for consumers with good to excellent credit.
4. Scheduled repayments
A personal loan can help you pay off your debt quickly and easily. You’ll know exactly how much is due each month and when your last payment will be. With a high-interest credit card, you could pay off your debt for years.
With a fixed repayment schedule, your payment and interest rate will stay the same throughout the loan, giving you peace of mind and no unexpected monthly debt payments.
5. Boost your credit score
By consolidating your debts into one monthly payment, you can make on-time payments more efficiently and improve your payment history. This makes up 35 percent of your credit score, so it can significantly impact you.
Even though it may seem like a good idea to close your old credit cards after you’ve paid them off, it could hurt your credit score. This is because the amount you owe and the length of your credit history are considered when calculating your score. So by keeping your cards open, you’ll have a better chance of maintaining a good score.
Debt consolidation can help improve your credit score, especially by making timely payments on the loan. Payment history is the most crucial factor in calculating your score, so consolidating debt can boost you significantly.
Consolidating debt has 4 drawbacks
There are also some downsides to debt consolidation that you should consider before taking out a loan.
1. On its own, it won’t solve financial problems
Debt consolidation does not mean you will never go into debt again. You may still spend beyond your means and rack up debt once you feel relieved of your current financial obligations. To prevent this from happening, make a budget that you can realistically stick to. Additionally, start saving up an emergency fund to cover unexpected costs, so you don’t have to put them on a credit card.
Consolidation can help you get a handle on your debt. Still, it won’t fix the underlying financial habits that got you into trouble in the first place. Changing your spending and saving habits can prevent more debt from accumulating.
2. Up-front costs may apply
Some debt consolidation loans come with fees. These may include:
- Annual fees.
- Balance transfer fees
- Closing costs.
- Loan origination fees
When considering a debt consolidation loan, ask about any associated fees. These can include late payment fees or prepayment penalties, varying significantly from lender to lender. Weighing the cost of these fees against the potential benefits of consolidating your debt will help you decide whether this is the right option.
Be sure to research the options thoroughly and read the fine print carefully. This way, you can be sure you understand the total costs of the loan.
3. There may be a higher rate for you
You may pay a higher interest rate on a debt consolidation loan than on individual debts. This could happen for various reasons, including having a lower credit score.
As debt consolidation becomes more popular, the interest rates offered to customers are becoming more and more based on their credit rating. The worse your credit is, the higher the cost of consolidating your debt.
The amount you borrow and the length of your loan term can affect the interest you pay. Taking out a loan for extended periods may reduce your monthly payments. Still, you could end up paying more in interest over the life of the loan.
When considering debt consolidation, it is essential to weigh your short-term needs against your long-term goals to find the best solution.
Consolidation may only sometimes be the best option for reducing your interest rate, especially with a less-than-perfect credit score.
4. You will be set back even further if you fail to make payments
Lenders typically charge a fee for missed or returned loan payments. These fees can add to your borrowing costs. To avoid such charges, make your monthly loan payments on time.
It’s essential to make your payments on time, every time. Late payments can damage your credit score and make it harder for you to qualify for future loans. To ensure you get all the costs, sign up for your lender’s automatic payment program if they offer one.
Before you take out a debt consolidation loan, make sure you can afford the monthly payments. Missing a payment can lead to late fees and a lower credit score.
Choosing whether or not to consolidate your debt
The answer to this question depends on your circumstances. That said, here are some scenarios where you might be a good candidate:
- You have a good credit score: A good credit score can save you money on interest rates. A score of 670 or higher is considered good and can help you secure a lower rate than you have on your current debt. This could save you money in the long run.
- You prefer fixed payments: A debt consolidation loan might be the best option for you, depending on your preferences for interest rates, repayment terms, and monthly payments.
- You want one monthly payment: This could be a good idea for people who don’t like keeping track of multiple expenses. This loan allows you to combine all your debts into one payment.
- You can afford to repay the loan: A debt consolidation loan can help you save money and get out of debt faster. But you must make sure you can afford the new loan payments before consolidating. Otherwise, you could end up in an even deeper financial hole.
Getting a debt consolidation loan
Before taking out a debt consolidation loan, there are a few things to consider. Here are a few steps to help you get started:
- Check your credit score and reports. It’s essential to keep an eye on both your credit score and reports. This way, you can make sure that everything is accurate and up-to-date. You can view all three of your credit reports for free every week by visiting AnnualCreditReport.com.
- Determine your loan amount. To see how much money you need to borrow to consolidate your debt, add the total amount you wish to reduce. Be sure to factor in any potential origination fees, as these will be deducted from the loan amount.
- Research different lenders. Many online lenders offer debt consolidation loans with varying eligibility requirements, terms, and fees. Comparing these options to find the best fit for your needs is essential.
- Get prequalified. Prequalifying for a loan is a great way to get an estimate of what your loan rate and terms could be. Lenders typically only do a soft credit check for prequalification, which means your credit score won’t be impacted. This is a great way to get an idea of what you can expect from different lenders.
- Apply. You’ll need to provide personal information when you apply for a debt consolidation loan, such as your name, date of birth, and income. The process will vary based on the lender you choose, but you may be able to submit your application online, in person, or by phone.
- Receive funds. Once approved for a debt consolidation loan, your lender can deposit the funds into your account as soon as one business day. You can use these funds to pay off your existing creditors and then repay the debt consolidation loan according to the terms of the agreement. Doing so will help avoid any damage to your credit score.
In summary
Debt consolidation can be a helpful way to manage your finances. Still, it’s important to remember that this approach has both benefits and drawbacks. By consolidating your debts, you can lower your interest rate and simplify your monthly debt payments. Still, you may also have to pay fees for a consolidation loan. Additionally, a loan will only solve some of your financial problems.
Consolidating your debts can be a great way to save money on interest and reduce your monthly payments. But it’s important to do your homework first. Review your monthly minimum payments and the expected time to repay the debt. Then compare that to the time and expenses associated with a consolidation loan. A debt consolidation calculator can help you see how a consolidation loan would affect your finances.
Consider many things before consolidating your debt, such as reflecting on what caused the deficit in the first place. It’s essential to address any root issues, like overspending, so consolidation is more likely to succeed.
