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Is debt consolidation right for you?

Debt consolidation can be a helpful tool to get out of debt, but only if you're willing to change your spending habits

Summary

With fewer payments each month and a potentially lower interest rate, a debt consolidation loan can help you get out of debt faster and easier. But if you’re still spending above your means, this isn’t a permanent solution.

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There are several ways to consolidate debt, including opening a balance transfer credit card, taking out a consolidation loan and using the equity in your home. Although there are significant differences among these methods, the overall concept is the same. You can merge multiple financial obligations into one, enabling you to save money and time.

Debt consolidation can be a powerful strategy, but it’s not right for everybody. Here’s what you need to know  to make the right decision.

When should you consolidate your debt?

There are a few circumstances when you should explore debt consolidation:

  • You have trouble managing many bills. Debt consolidation may be a good idea when handling multiple creditors becomes too difficult. When bills come in at different times and have their own due dates, it’s easy to get stressed out and then miss payments. Your stress level can be greatly reduced with just one creditor to pay every month.
  • You are overpaying for financing. Some credit products have very high interest rates, making them too expensive to pay off within a reasonable amount of time. If you can consolidate them so you get a lower average rate, the merger will reduce the total financing costs. The less you pay in interest, the faster you can pay off debt, too.
  • It will improve your credit. If you have been delinquent with payments or have credit card balances that are too close to the limit, debt consolidation can give your credit a boost. You may be able to get back on track by meeting all future payment due dates and lowering your credit utilization ratio. When your credit rating escalates, you will have even more borrowing opportunities available to you, from low-cost loans to premium credit cards.

Is debt consolidation right for you?

While debt consolidation can be immediately appealing, it also has to make sense for your situation. Consider the pros and cons:

Pros of debt consolidation

  • One account is easier to handle than multiple ones.
  • You’ll save money with a lower overall interest rate.
  • You can get out of debt faster.
  • You can improve your credit score.

Cons of debt consolidation

  • You may not qualify for consolidation.
  • It can put you in a worse position if you miss any payments.
  • Payments can be higher than the ones you have now.
  • You may be trading unsecured debt for secured debt.

Consolidating is a serious financial step. The payments have to be within reach — and not just over the short-term. Analyze your budget and make any necessary changes. If you don’t, you’ll fall behind and your credit will be negatively affected.

You also don’t want to put yourself in a more precarious position than you are now. Depending on the option you pursue, you may be trading unsecured debt for debt that is secured by valuable property.

Additionally, you will have to meet the lender’s qualifications. There could be credit score, income, and equity restrictions. If you don’t meet them, this won’t be an option for you.

Debt consolidation options

There are a number of options for debt consolidation. Here are the most common and when each may be an appropriate choice.

Balance transfer credit cards

Balance transfers allow you to move existing credit card debt onto a new card. Most offer introductory periods of 0 percent interest, which are typically 12 months but can be even longer. During that time, no financing fees will be added to the transferred debt, though there is usually a balance transfer fee of between 2 percent and 5 percent. A balance transfer credit card can be great for debt consolidation when your credit scores is good enough to qualify, you have the means to pay off the debt before the regular rate goes into effect (which is generally slightly lower APR than the national average credit card APR), and the new card will absorb the bulk of your obligations.

Consolidation loans

A consolidation loan is a type of personal loan in which the lender takes on the debt you currently have. You would repay the loan in even monthly installments, and the terms are often one to five years. Interest rates typically range from low to high, though, so make sure you don’t switch a lower rate for a higher one just for convenience.

Home equity cash-out refinancing

If you own a home, you can apply for a cash-out refinance and use the money to pay off your other debts. It will leave you with a higher principal balance. This method can offer valuable relief because interest rates on home loans are low, but it comes with some downsides. It can cost 2 percent or more of your outstanding mortgage loan amount, and you’ll need enough equity in your home to qualify. Lenders frequently cap the amount you can borrow at 80 percent of your existing equity. It does come with a serious risk, too. If you can’t make the payments on your new refinanced loan, it puts your home in danger of foreclosure.

Home equity loans and lines of credit

Another option if you’re a homeowner is to take out a home equity loan or line of credit. Both let you convert a portion of the equity you’ve built into cash, which you can use to pay off other, higher-interest-rate debts. As long as you have good credit, the loan or line can have a significantly lower interest rate. The downfalls are the same as with cash-out refinances, though. You must have sufficient equity, and you could lose your home if you fall too far behind on payments.

Bottom line

Debt consolidation can work in your favor but you need to be sure you’re making a wise decision. Think carefully and plan accordingly. When you take advantage of the right option, you will feel in control of your money and be able to see the light at the end of the debt tunnel.

Editorial Disclaimer

The editorial content on this page is based solely on the objective assessment of our writers and is not driven by advertising dollars. It has not been provided or commissioned by the credit card issuers. However, we may receive compensation when you click on links to products from our partners.

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