The Basics Of Debt Consolidation: Is It A Good Idea For Improving Your Finances?

A guide for understanding the basics of debt consolidation and if it’s the best option for getting rid of your debt.

Being in debt is one of life’s most daunting challenges. When you are in the phase of debt that is manageable or your bills need to be better organized, debt consolidation can provide relief and place you on the road to paying off your debt sooner before it gets out of control.

 Debt consolidation is a strategy that many finance experts recommend for getting a hold of a dire financial situation before it escalates. However, How can debt consolidation be a solution? 

What Is Debt Consolidation?

Debt consolidation merges credit card and student debt, high-interest loans such as auto and personal loans, and multiple bills into a single payment.

The ideal person to benefit from debt consolidation is anyone who is overwhelmed by financial problems. The goal of debt consolidation is to reduce your debt and organize it so you can pay it off more quickly. 

How Does Debt Consolidation Work?

 Debt consolidation offers a few options such as personal loans, credit balance transfers, home equity, and student loan consolidation are ways debt can be managed and paid off sooner. The primary purpose of debt consolidation is to combine your debts into a single loan with one monthly payment. 

Personal loans

Various banks, specialized debt consolidation online lenders, and credit unions offer borrowers personal loans to consolidate their debt. Debt consolidation loans work like monthly installment payments. It’s helpful because you have a set fee every month. Therefore, you know how much you need to pay each month and the amount of time until you pay off your loan.

 It’s vital to understand the terms, interest rates, and fees a personal loan may have, which can change the total amount you will have to pay. Often a lender will do a soft credit check to see what interest rate the borrower qualifies for best. 

Balance Transfer

A balance transfer is a debt consolidation option that allows existing debt to be transferred over to a credit card. A credit balance transfer works when the borrower opens a new credit card with a low-interest introductory rate. 

The borrower can transfer their current balances to a new card. Often, credit cards will have offers that have 0% interest for a balance transfer. Also, after being approved for a balance transfer, you may be able to transfer multiple debts onto one card. 

Before considering a balance transfer option, clearly understand the terms, applicable transfer fees, and when the actual interest rate will start after the promotional interest rate ends. In addition, be sure you know the card’s credit limit before you begin to transfer all of your balances over to a new card. 

Home Equity

Taking out a home equity loan to consolidate debt means the borrower can use the equity from their home. This means a borrower’s home is used as collateral. Money made available to the borrower is a significant amount. Therefore, the borrower can pay off existing debts. 

After the distribution of the money, the borrower pays a fixed interest rate and monthly payment. Usually, the interest rate is lower because your home secures it. Additionally, monthly fees for a home equity loan are more moderate because of the low-interest rate. 

The primary risk of a home equity loan is that if you cannot make the monthly payments, you could lose your home. This is a debt consolidation option you should consider very carefully and talk with a financial advisor to see if taking out a home equity loan is right for you.  

The Difference Between Student Loan Consolidation And Student Loan Refinancing

The two different types of student loan consolidation are private and federal.

 A personal student loan consolidation is known as refinancing. Often, it’s an option you do through a private lender. A federal student loan consolidation is a combination of multiple federal loans reduced to a single federal loan provided by the Department of Education.  

Student loan Consolidation

•  Only able to combine federal loans.
•  Student loan consolidations offer lower payments by loan extension—however, the interest rate increases over time. 
• One monthly payment.
• You have access to federal loan protections, forgiveness programs, and repayment options.

Student Loan Financing

•  You can combine private and federal loans.
•  Lower rates.
•  You can combine personal and federal loans into one personal loan. 
•  You save money.
•  Only have to pay a monthly payment.

Is Debt Consolidation A Good Solution?

Now that you know your options for debt consolidation, the most critical question to answer is whether debt consolidation is a good idea. Before you decide to go into a debt consolidation plan, you must carefully consider the pros and cons. 

The Pros Of Consolidating Debt

1. An Efficient Way To Handle Your Finances

Consolidation can take away the anxiety of paying multiple payments and high-interest rates every month by combining everything into one monthly payment. 

                        2. Lower Interest Rates To Pay Off Your Debt 

Debt consolidation with suitable options will provide a reduced interest rate to your debt at 10 percent or less

3. Avoid Damage To Your Credit

 Taking the step to consolidate your debt gives you the advantage of getting ahead of your debt before it gets worse. By taking the initiative to consolidate your debt, you can avoid damaging your credit score by late or not paying your credit payments. In addition, you can prevent bankruptcy. 

The Cons Of Debt Consolidation

1. Could Be A Challenge If Your Credit Is Bad

Bad credit can cause applying for a loan to be a challenge. You can still get a loan; however, your interest rate could be higher than some of your current debt interest rates. If you apply for a personal loan and there are no origination fees, usually the requirement of a fair credit score of 660 and above is needed. 

2. Read The Fine Print Before Taking On A Debt Consolidation Loan

Many debt consolidation loans have fees. Be sure to look over any fees that are associated with the debt consolidation loan that you are interested in, such as: 

•  Balance transfer fees
•  Annual fees
•  Loan origination fees
•  Closing costs

Research and read the fine print to know what the total costs of everything are. You don’t want to be overwhelmed or surprised by unexpected fees.

3. Missed Payments Can Lead You To More Financial Trouble

Late monthly payments can lead to costly late fees. Have a set amount ready every month to pay your monthly debt consolidation loan payment. If you have a payment that returns to you, it’s because of insufficient funds. A lender could charge you a returned payment fee. Therefore, your borrowing costs can increase considerably. 

In addition, if you have late payments, lenders usually will report a late payment to the credit bureaus after it is past due 30 days later. Therefore, you could have a damaged credit score. To avoid a financial problem such as this, enroll in an automatic payment program if the option is available. 

Before you decide to take a step into debt consolidation, have a conversation with a financial professional that you can trust before making your final decision and knowing what is best for your situation.

Disclaimer: This blog article is for information purposes only. Always consult with a professional financial advisor before making decisions about your finances.