Debt consolidation is the process of taking out a loan in order to consolidate, or combine, multiple debts into one. It does not eliminate your debt completely, but rather, it rolls it up into one more manageable loan, often with a lower or fixed interest rate.
If you are overwhelmed with your current debt and are serious about working toward becoming debt free, debt consolidation might be able to help you reach your goal. Here are 5 reasons debt consolidation can help.
Lower interest rate
The major reason debt consolidation can be beneficial is because it often offers a lower interest rate. While you may have multiple credit cards with interest rates as high as 20 plus percent, rolling all your debt into one loan might lower your interest rate.
However, debtors beware. Sometimes while there is a lower interest rate, there are higher fees involved. Also, the terms of the loan (the length of time in which you will be making payments) might increase. So make sure that the lower interest rate doesn't come with any hidden fees or charges and ask about the length of the payments.
In addition, sometimes the lower interest rate is due to the new consolidated loan being secured. Most credit cards are unsecured loans, meaning there is no tangible personal property to back the debt. This is in comparison to a secured loan-such as your car or home. Secured loans mean lower interest rates because there is less risk to the lender. If you fail to make payments on your home, the lender can foreclose on the property. They cannot do this with other types of debt.
So understand that the lower interest rate offered is often at the price of a lower risk to the lender, but a higher risk to you. If you consolidate credit card debt into your home loan, and fail to make payments, you might lose your home.
However, if you are serious about getting out of debt and feel comfortable that you are able to make the consolidated payments with no risk of default, you could benefit from the lower interest rate offered.
Frequently Asked Debt Consolidation Questions
Debt Consolidation = Lower monthly payments
This is simple math. If you get a lower interest rate loan that doesn't have longer terms, it will your monthly payments will be reduced. For example, if you owe $10,000 at a rate of 21%, and you want to pay it off in five years, your monthly payment would need to be $270. If you had a lower interest rate of 8% and still wanted to pay off the debt in 5 years, your monthly payment would be $202 per month. With a lower monthly payment, you can afford to make extra payments to reduce the amount of time it takes to pay off the loan.
Debt consolidation can offer greater simplicity in your debt management. It can be overwhelming and confusing receiving multiple credit card statements every month. It can be difficult to keep up with due dates, balances, payments, terms, rates, etc. With debt consolidation you make only one payment per month. This means you are less likely to miss a payment due to confusion. It will also reduce the number of creditors you talk to and deal with. If you have questions or concerns regarding your loan, you have only one company to communicate with.
Free Debt Consolidation Counseling
One big benefit of debt consolidation is that many companies offer free debt counseling services as a perk. Debt counseling provides financial education on how debt works, how to protect you, and how to use debt responsibly.
Recent Debt Consolidation Questions
Get out of debt!
As mentioned, if you are serious about getting out of debt, debt consolidation can be a great start. While it will not eliminate debt, it will allow you to organize your debt into a more manageable form. With a lower interest rate and lower complexity, you can focus on reaching your goal of becoming debt free quicker and easier.
About debt consolidation and your credit score
Debt consolidation can have a neutral, negative, or positive impact on your credit score. As mentioned, debt consolidation does not eliminate your debt; it simply combines it into one loan. In this sense, you are not decreasing your debt to income ratio or amount of debt. In this sense, there is a neutral effect that this has on your credit score.
On the negative side, if through your debt consolidation, the company negotiates lower balances than what you owe, it may hurt your credit. This is because you are not paying the full amount owed.
As a positive, your score might improve due to the fact you are making timely payments. If you stick with your debt management plan and decrease your debt because of the lower interest rate offered through consolidation, this is likely to improve your credit score over time.
As a recap, here are some important notes to remember about debt consolidation:
- Debt consolidation does not eliminate your debt, but rather, rolls multiple debts into one more manageable loan, often with a lower interest rate.
- Because your interest rate is likely to decrease, your monthly payments will be smaller.
- Debt consolidation will simplify your life by decreasing the number of different creditors you deal with.
- With more manageable debt, it is probable you can work your way toward becoming debt free sooner and over time, improve your credit score.