What is Debt Consolidation?

Managing multiple debts can be overwhelming and stressful. Many of us that are in debt are constantly trying to find a way to get out of it. You have probably come across debt consolidation and seen that it could help you pay off your debt faster. Debt consolidation offers a way to simplify your financial life by combining several debts into one payment. It’s no wonder that many people are curious about debt consolidation and how it can help. In this post, we’ll explore what debt consolidation is, how it works, and whether it might be a good option for you.

Debt consolidation rolls multiple different debts into one payment. It is typically used for higher interest rated debt, such as credit cards. It is important to note that consolidating your debt does not combine all of it into a single debt, but a single payment.

There are two primary methods in which many people consolidate their debt – debt consolidation loans and balance transfer credit cards. We will explore each method as well as the pros and cons, so you can decide if this is a good strategy for you!

Debt consolidation loan

A debt consolidation loan is a personal loan that you can get from many different types of lenders. Personal loans have set repayments terms, which can help to lower your total amount of payments that go toward interest. This is especially true when dealing with credit card and other high interest debt.

It is important to note that you need to have good credit to make this loan worthwhile. The terms of the loan will be heavily based off of your credit score and history. You can get approved with poor credit, but the terms will be worse due to you being a higher risk client. You will also likely have a higher interest rate if you have a lower score. If this is the case, it may not be worth it to get the loan.

It is also important to consider the lender origination fees as these are usually a percentage of your loan amount. These fees are typically deducted from your loan disbursement. This meaning you will have to get a higher loan amount to ensure you have enough to cover your debt and origination fees.

Finally, it is important to know what your entire monthly payment will be. You must be sure you will be able to make your payment – every. single. month. If you skip or cannot make the full payment every month, you will only dig yourself in a bigger hole. In this case, it can be beneficial to budget monthly. This will ensure you can make the payments every month and get out of debt!

While a debt consolidation loan is beneficial to many people, it can be a detriment to others. You need to analyze your situation and research different options to see what strategy is best for you.

Balance transfer credit card

Balance transfer credit cards transfer your credit card debt to a single credit card. This can also be referred to as credit card refinancing. Ideally, these credit cards offer a 0% interest rate for a promotional period – typically around 9 to 21 months. This is a great option because of the introductory 0% APR period. This usually gives you over a year to pay off debt without interest. While it may help you pay off your debt faster there are things to consider when looking into these credit cards.

First, it can be difficult for many people to qualify as you need to have a good to excellent FICO credit score, at least 670 or more. Further, these credit cards typically have a balance transfer and a higher interest rate once the promotional period has ended. It is not guaranteed that you will be able to transfer all of your debt. If you have debt that is greater than the credit limit, you cannot transfer all of your debt. This can make things especially difficult since you don’t know your limit until you have been approved for the card.

For example if you get approved for a balance transfer credit card with a $20,000 credit limit, but you have $30,000 of debt. You will only be able to transfer the $20,000 of your debt and have to continue making separate payments on the other $10,000.

If you are looking into this, it is important to do your research and due diligence to see if it is a good idea for you. How much debt you have is a big consideration when looking into balance transfer credit cards.

Is consolidating debt a good idea for you?

Yes:

Debt consolidation is a good idea if the interest rate is lower than your debt you currently have. If you will be paying a lower amount of money in interest overall, then it is probably a good idea as this will save you money in interest payments over time.

If you have enough cash flow each month where the monthly payments do not exceed 50% of your gross monthly income, debt consolidation could be good for you. If you have enough cash flow to cover your payments and all other bills every month, you could consider consolidating debt.

Debt consolidation can help you to build or repair your credit. As well as help you payoff your debt off faster and make timely payments.

No:

Debt consolidation is not a good idea if your debt to income ratio is too high. A good benchmark to go off of is 50%. This meaning if your debt is greater than 50% of your income, it is likely not a good idea for you to consolidate your debt.

It is not a good idea if your debt is due to poor spending habits. If you have poor spending habits, no matter how much debt you consolidate, you will continue to struggle to make payments. In this case, it is better to budget and develop better financial habits before consolidating your debt.

Consolidating your debt is probably not a good idea if you have a poor credit score. Not only will it be difficult to qualify for debt consolidation, but you will also have worse terms and a higher interest rate.

Conclusion:

Debt consolidation can be a powerful tool for managing multiple debts and reducing the overall interest you pay. By rolling several high interest debts, such as credit card balances, into a single monthly payment, you can simplify your finances and save money. It is important to understand that debt consolidation does not combine all your debts into one, but rather merges them into a single, more manageable payment. We explored the primary methods of debt consolidation – debt consolidation loans and balance transfer credit cards. There are other options to consolidate your debt, such as home equity loans, debt settlements, retirement accounts, etc. However a personal debt consolidation loan and balance transfer credit cards are the most common methods to consolidate debt. Now that you understand the basics, you can continue your research on specific strategies and decide if debt consolidation is the right for you!

Source List:

Nerd Wallet – Balance Transfer

Investopedia – Balance Transfer

Nerd Wallet – Consolidate Debt

Experian – Debt Consolidation

Nerd Wallet – Consolidate Credit Card Debt

What is Debt Consolidation?