Keeping track of payments and balancing outstanding debts is challenging, especially if you already have personal loans, an auto loan, and a late credit card payment.
Fortunately, consolidating your debts into a single loan can streamline your finances and help you alleviate the financial burden. This is where debt consolidation comes in.
However, getting debt consolidation loans also poses some challenges. Therefore, you should check the pros and cons of debt consolidation before taking a new loan.
Do you want to know if debt consolidation is the right way to pay for your loans? Here's everything you need to know about this strategy.
What Is Debt Consolidation?
Before going over the pros and cons of getting a debt consolidation loan, it's essential to understand what debt consolidation is.
Debt consolidation is the act of paying multiple debts with a new loan and, usually, a lower interest rate. Many people also use a balance transfer credit card as a debt consolidation option.
Also, many lenders offer debt consolidation loans, but a standard personal loan can work.
However, debt consolidation doesn't just mean using new credit cards and taking out another personal loan to pay off existing debts. The process involves using proceeds to pay off each individual loan through a smart strategy.
How Does Debt Consolidation Work?
There are many options available when it comes to debt consolidation.
People can get debt consolidation loans from a lender to pay off their debts. However, some lenders also pay off loans on behalf of borrowers.
Other lenders disburse the proceedings. As a result, borrowers can make the payments themselves.
As mentioned, using a balance transfer credit card is another option, as qualified borrowers typically get access to a 0% introductory APR for up to two years.
However, most debt consolidation options work the same way:
- Take out a debt consolidation loan (it can be a personal loan, a credit card, or another option)
- Use the proceeds of the new loan to pay off old debts
- Pay off the debt consolidation loan (there are new repayment terms)
Debt Consolidation Example
To better understand how debt consolidation works, check out this example:
You have $20,000 in credit card debt, but the amount is split between three credit cards. The interest rate for each credit card is above 20%.
Let's say you take a new personal loan of $20,000. However, this personal loan has an interest rate of 10% and a five-year repayment term length.
This new personal loan can help you pay off your old credit card debt and save money on interest payments in the long run. But first you need to understand what kind of loans are offered on the market before getting one reserved for you. Just sign up in one of the services that provide
Is Debt Consolidation a Good Idea?
Did you understand how debt consolidation works after reviewing the example? It seems so easy to pay your existing credit card debt with a new personal loan, right?
Before making a decision, it is important to answer another question: is taking a debt consolidation loan a good idea?
Overall, debt consolidation loans are great options for borrowers who have several loans with high-interest rates.
However, a debt consolidation loan may only be favorable to a person whose credit score has improved since they applied for the original loans.
If your credit score is not high enough to qualify for a new personal loan with lower interest rates and new repayment terms, according to the standards set by the lender, debt consolidation doesn't make sense.
Also, taking a debt consolidation loan is not the best idea if you have not identified and addressed the issues that led you to accumulate huge debt.
Using a debt consolidation loan to pay off multiple credit cards shouldn't be seen as an excuse to overspend money and run up the balances again. Also, doing so can greatly affect your personal finances and credit score.
Pros of Debt Consolidation
From lower interest payments to paying off your current debt with a single check, getting a debt consolidation loan brings many benefits. These are the main ones:
- Paying off multiple outstanding debts with a single personal loan reduces the payments and interest rates you have to worry about each month.
- Using debt consolidation to pay off your current debts reduces the chances of making a late payment, which improves your credit.
- Debt consolidation usually results in less interest. If you use the money you save each month on each payment, you can make early payments and improve your credit score even more.
- If you have a good credit score, you could lower your overall interest rate. Shop around and choose lenders offering a personal loan prequalification process to get the most competitive rate and repayment terms possible.
- Getting a debt consolidation loan could also reduce monthly payments since there aren't too many personal loan payments but an extended loan repayment term.
- Debt consolidation can reduce your credit utilization rate, positively impacting your credit score.
Cons of Getting a Debt Consolidation Loan
Whether you get a debt consolidation loan or use a balance transfer credit card, both options are good for streamlining debt payoff.
However, debt consolidation also has some disadvantages, including the following:
- Taking out a debt consolidation loan may come with an additional fee, such as a balance transfer or origination fee. Most people must also pay origination fees and an annual fee. You can also get your application approved based on the information you provide your bank with. Having a good past credit history means that all your past credits were paid on time. Based on this data, a lender or bank can cut down fees. To learn more you need to contact any local financial consultant and receive a free initial consultation.
- Debt consolidation is a smart decision for people with a good credit score who qualify for lower interest rates. If your credit score is not high enough, you may have to pay more in interest over the life of the loan. They will check a range of factors and let you know what to expect after you will apply for a new loan.
- When you apply for some new personal loans to consolidate your debts, the repayment goes from the day you get the loan up to seven years. While the monthly payment may be lower, you may have to pay more on interest over the long loan term. Checking their credit history is an excellent way for all applicants to understand the impact of their potential financial decisions.
- Taking out a debt consolidation loan and missing payments can negatively impact your credit score. Based on this information a further interaction with your bank can be more expensive. Take these factors into account when sending an application for any consolidation or personal loans. You may contact your bank for further assistance.
- Debt consolidation doesn't solve the issues that cause your huge debt and may encourage increased spending. Overall, you shouldn't see the new personal loan as an excuse to apply for a few more personal loans.
Final Thoughts
Debt consolidation loans are great for many people, from business owners to those who just want to start saving but have high debt on their credit cards or must make huge monthly payments.
However, although they bring many benefits, debt consolidation loans also have several disadvantages.
As mentioned, a debt consolidation loan can affect your credit score. Also, if unable to find a bank offering competitive rates, as a customer you could end up paying more in interest.
Therefore, before considering taking out a new personal loan or using a balance transfer credit card to consolidate your debts, you should check out the pros and cons of debt consolidation.