The process of obtaining a larger loan or credit card in order to settle smaller, already existing debts is known as debt consolidation. You could get better payback conditions, such as a reduced interest rate or fewer monthly payments, or perhaps both, by consolidating many smaller loans into one bigger one. Here are the steps to take if you decide to combine your debts and how to make that decision.
What is Debt Consolidation?
Debt consolidation is when you take out a new loan or credit card to pay off other loans or credit cards. By combining several loans into one bigger loan, you might get better terms for paying it off, like a lower interest rate, monthly payments, or both. Find out if you should consolidate your bills and how to do it if you decide to.
Using the money from the personal loan to pay off each loan is part of reducing debt. Some lenders offer particular loans for consolidating debt, but most personal loans can also be used. In the same way, some lenders pay off loans for borrowers while others give the user the money so they can pay it back themselves.
Debt consolidation is a good idea that you can do on your own if you only have a small amount of debt and just want to arrange your bills with different interest rates, payments, and due dates.
Types of Debt Consolidation
Paying off credit card debt, personal loans, and high-interest student loan debt can be simpler by choosing one of the many debt consolidation options.
Balance Transfer Credit Card
If you have more than one credit card debt, a balance transfer credit card can help you pay them off faster and save money on interest. A balance transfer credit card moves several lines of high-interest credit card debt to one card with a lower interest rate. This is similar to a debt consolidation loan.
The introductory period for most debt transfer credit cards is 0% APR for a certain amount of time, usually between 12 and 21 months. You could save a lot of interest if you can pay off all or most of your debt during the introductory time.
Home Equity Loan
You can use the wealth in your home to get a home equity loan, sometimes called a second mortgage. You can borrow up to 85% of your home’s value minus any remaining mortgage balances. Most home equity loans have terms of five to thirty years to pay them back.
Because your home is used as collateral, home equity loans have lower interest rates than credit cards and personal loans. On the other hand, if you don’t repay the loan, your home could be taken away.
Debt Consolidation Loans
Debt consolidation loans have fixed rates and terms. You pay them back by making monthly payments over a certain amount of time. It would be best to have good credit and a steady income to get a debt-reduction loan. If you want the best interest rate, you might need a credit score of 740 or higher.
Student Loan Refinancing
If you have student loans with high interest rates, you might be able to get a cheaper interest rate by refinancing them. When people refinance their student loans, they can combine their government and private loans into one private loan with a single monthly payment.
Refinancing can be a great way to combine your student loans, but you’ll still need to meet specific standards. Also, if you refinance your federal student loans, you’ll lose government protections and benefits, such as the ability to defer or adjust your payments based on your income.
Personal Loan
This kind of loan could come from a bank, credit union, peer-to-peer lender, friend, family member, or even a stranger. Most personal loans are unsecured, which means the user doesn’t have to put anything up as security.
That might mean the interest rate increases, and there is less money for the loan. The interest rate will be less if you have good credit.
Advantages of Debt Consolidation
Below are some of the advantages of debt consolidation:
Lowered Total Interest
You could save hundreds of dollars on your loan if you combine several bills with interest rates in the double digits into a single loan with an interest rate below 10%.
Easy Ways To Pay Back Debt
When you have a lot of credit card or loan payments due each month on different dates, it can be hard to keep track of them all. Getting a debt reduction loan makes it easier to plan your month and make payments on time.
Boost Your Credit Score
If you merge your debts, your credit score might go up. Your credit utilization ratio could decrease if you use debt consolidation to pay off your credit cards, and your payment history could improve if you make your payments on time with a debt consolidation loan.
Disadvantages of Debt Consolidation
Here are some of the disadvantages of debt consolidation:
Upfront Costs
Of course, some fees could come with any kind of debt consolidation. These include origination fees and balance shift fees, which could lower the value of your loan overall. Before you apply, make sure you understand the lender’s rules.
Some Forms Requires Collateral
Any protected loan, like a home equity loan or HELOC, can be used to pay off your debt. If you don’t repay the loan, the collateral can be removed.
Higher Rate
How much you can save will depend significantly on your loan setup. If the interest rate stays the same but the time you have to pay it back is longer, you will pay more in interest over time.
How to Decide If Debt Consolidation Is Worth Considering
If you meet a few conditions, consolidating your debt might be the best thing for you:
- Because of your credit score, you can get a reasonable rate.
- Paying off your debts would take you longer than a few months.
- You need an easier way to pay back the loan.
Consolidating your debt is sometimes a good idea, but not always. Because of these things, it might not work as well.
- You aren’t sure if you can afford a more significant monthly payment on a debt reduction loan.
- Your credit isn’t great, and you don’t have a cosigner or a low rate to help your chances of getting something.
When You Shouldn’t Consider Debt Consolidation
Getting rid of debt and improving your credit score can both be helped by consolidating your debt. But before you sign, you should ensure you can afford the monthly payment. If the payment is too much for you to afford, and you fall behind, it could hurt your credit score.
Look at your credit score before you take out a new loan, especially if you’re combining debt. The lender won’t give you their best rates if your credit score is low or you don’t have a credit background. Getting a loan and a better rate might be easier if you have a cosigner with good credit.
Debt Consolidation and Your Credit Card
A loan to pay off your debts may help your credit score over time. By making your monthly payments smaller, you should be able to pay off the loan faster and lower your credit utilization ratio. This measures how much debt you have compared to how much money you owe.
That can help your credit score increase, making it more likely that lenders will let you borrow money and give you better terms.
One thing that might happen is that rolling over old loans into a new one might hurt your credit score at first. This is why credit scores like older debts with longer, more stable payment records.
How to Apply For Debt Consolidation
Applying for a debt reduction loan can be less scary if you know how to do it. If you want to apply, do the following:
1. Review Your Financial Situation
Start by adding up all of your credit card bills. This will help you figure out how much of a loan you need. Also, write down your APRs. It would help if you were sure that the APRs you can get on a debt consolidation loan will save you money.
Also, check your credit score, review your credit records, and dispute any mistakes. Knowing your credit score beforehand lets you get better ideas of what lenders will accept you.
2. Get Prequalified
Prequalifying for a personal loan doesn’t mean you’ll get one, but it can help you understand what APRs and loan terms you might get by giving some basic information about your finances.
Getting prequalified only takes a few minutes and won’t hurt your credit score. The process should be done with multiple loans to pick the one with the best terms.
3. Look At Different Lenders
APRs, fees, payback terms, and loan amounts should all be compared between lenders once you have a few prequalification offers.
4. Apply
When you apply for the loan, the lender will check your credit report and probably ask for proof, like pay stubs. You might also have to show how much money you owe and who it is.
5. Wait For Feedback
You might get approval the same day, depending on how long the lender takes to pay the loans. You might have to wait a few days for some. Once approved, the money is typically ready in one or two more business days.
6. Pay Off Debt With Loan Money
Some lenders will put the loan money straight into your bank account, while others will pay your other creditors. When the loan gives you the money, use it to pay off the debt you want to combine. Please don’t give in to the urge to spend them on things that aren’t connected.
7. Payback
Most of the time, your first loan payment is due about 30 days after you get the loan. To keep your credit score high and avoid going back into debt, always pay on time and in full.
Conclusion
Combining your debts into one payment can help you pay them off faster and save money on interest over time. A personal loan, a new credit card, or a home equity loan are just a few ways to bundle your debt.
