Everything You Need to Know
When you have multiple credit card or loan payments due every month, it can be tough to stay on top of things, even simply from an admin standpoint. Between tracking minimum payments and trying to decipher the interest rates on each loan to decide which one to prioritize, managing your debt can quickly become a logistical nightmare.
If you’re stuck paying multiple loans with high interest rates, debt consolidation might be the path forward.
Read on to learn what debt consolidation entails, how you might use it to your advantage, and whether this strategy is right for you.
What Is Debt Consolidation?
Debt consolidation is the process of taking out a loan and using it to pay off your other outstanding debts. Then, instead of juggling payments to multiple lenders each month, you make just one monthly payment.
One of the main advantages of consolidating debt is the opportunity to secure a lower interest rate than you’re currently paying. If you have several loans at different interest rates, do some math to determine what terms to look for when securing a debt consolidation loan.
Whether you have credit card debt, student loans, medical debt, or something else, bringing down the amount of interest you’re paying each month will help you put more money toward the principal and pay off debt faster.
How to Consolidate Your Debt
There are several avenues you might pursue when looking to consolidate your debt. Ultimately, the type of debt you’re carrying and the repayment terms you can qualify for will inform which method you choose.
The two most popular ways to consolidate your debt are through balance transfer credit cards or with fixed-rate debt consolidation loans.
Balance transfer credit cards:
These credit cards usually offer 0% interest for a set introductory period (usually 12 to 18 months) for balances transferred from other credit cards. You’ll have to do some quick math, though. Often there’s an initial balance transfer fee, plus, you may be on the hook for an annual credit card fee as well. As long as those fees are less than the interest you’d pay on your existing card, and you can make the payments before the 0% interest period ends, balance transfer cards are a powerful debt consolidation tool.
Fixed-rate debt consolidation loans:
These are personal loans that you can secure through banks, credit unions, or private companies. Usually, these loans have a set term of anywhere from 6 months to 10 years, so you know exactly when you’ll be finished paying. This type of loan is only advantageous if you can secure a more favorable interest rate than you’re currently paying. Debt consolidation loans may be secured or unsecured; unsecured loans do not require you to put down collateral, while secured loans require collateral such as your home or car.
Additional types of debt consolidation loans include:
Home Equity Lines of Credit (HELOCs):
You can use the equity you have in your home to secure a home equity line of credit (HELOC) loan which acts as a revolving loan. These loans function like a credit card, enabling you to borrow up to a certain amount, pay it off, and then borrow it again.
A Home Equity Loan:
Does Debt Consolidation Affect Your Credit Score?
Debt consolidation may affect your credit score negatively, but likely only in the short term.
Since you’ll have to take out an additional loan to consolidate your debt, a hard credit inquiry is required. This will cause a slight drop in your credit score.
Additionally, if you close any loan accounts in the consolidation process (because you’ve now paid them off in full), this could cause a decrease in your credit score. Part of your credit score is based on the age of your credit accounts, so your score will dip if you close any, especially if it’s a long-standing account.
Don’t worry, though– as long as you continue to make on-time debt payments and consistently lower your debt-to-credit ratio; your score will soon recover.
Advantages Of Debt Consolidation
Debt consolidation has several advantages, but only if you can find and qualify for loans with favorable terms. Assuming you can do this, consolidating your loans will help you pay less interest overall, helping you get out of debt faster.
Having just one loan payment each month makes it easier to keep track of your payments and ensure you make them on time. Given that on-time payment accounts for 35% of your credit score, this will help you boost yours.
Additionally, since debt consolidation loans typically have a fixed repayment schedule, you’ll know exactly how much you’ll pay each month and when your last payment will be. This makes it easier to plan your finances and provides a light at the end of the proverbial tunnel.
Debt consolidation might feel like a fresh start for those working to repair credit. If collections agencies are badgering you, the funds from your loans will quiet them. Then you can begin rebuilding credit by maintaining a positive payment history on your new loan account.
Having good credit will open doors for you by making it easier to qualify for products like mortgages or auto loans, and enabling you to secure lower interest rates. Debt consolidation can be a powerful way to accelerate paying down debt and improve your credit score.
Disadvantages Of Consolidating Your Debt
- Your credit score may fall temporarily when you consolidate debt—the length of your account history factors into your credit score. If you close out one (or several) long-standing accounts after paying them off, your score will likely dip. The positive data from your new loan account will help it recover quickly, but this is still something to keep in mind. If you plan to apply for another loan in the near future, you likely want to keep your score in tip-top shape.
- Depending on the term of your loan (the length of time you take to pay it back), you may end up paying more than you originally owed, even if you secure a lower interest rate. In some cases, this may make sense if it enables you to make payments on time and protect your credit. Analyze your financial situation carefully to determine whether it’s really worth paying more in the long run.
- There may be fees associated with taking out a new credit card or loan. Look out for balance transfer fees, loan origination fees, annual fees, and any other additional charges that may be buried in the fine print.
- If you can’t qualify for an unsecured loan, you may be asked to put up collateral such as your home or vehicle to back up your debt consolidation loan. Be very careful with this, as you could lose your assets if you fail to make your payments.
- If you have a low credit score or negative data on your credit report, you may struggle to secure a lower interest rate than your existing debts. Or worse, you may not qualify for a debt consolidation loan at all.
What Are The Requirements For Debt Consolidation?
Usually, to qualify for a debt consolidation loan or a balance transfer credit card, you’ll need to demonstrate creditworthiness and a source of income.
The exact documentation needed will vary depending on your lender, but here’s what you should plan to have in place when applying for a debt consolidation loan:
- Bank statements or pay stubs proving you have sufficient income to cover the monthly payments
- A letter of employment
- A credit score in the fair to good range (650 or higher)
Is Debt Consolidation Right For You?
Ultimately, consolidating your debt can help you pay it down quicker and save you money on interest, but it isn’t a substitute for solving more significant financial problems. For this strategy to benefit you, the numbers need to make sense.
Typically, you need to be able to secure a lower interest rate than what you’re currently paying. Usually, you won’t be able to do this unless you have a favorable credit score or are willing to put up collateral to secure a loan.
In the event that you can’t secure a lower interest rate, it may still make sense to consolidate if it means you can avoid falling behind on payments. Though you’ll pay more in interest, it may be worth it to protect your credit score and overall appearance of creditworthiness.
If you struggle to keep up with payments or have a low credit score, you may not qualify for debt consolidation options. If this is the case, spend some time assessing your financial situation and devise a plan to improve your credit score.
You may have already gone on a path to bad credit. But not to worry, we’re here to help. CreditBull.com can help with all of your credit needs.
CreditBull Inc has over 20 years of experience in credit and financial matters. And we specialize in helping you come out of a bad credit situation. We know how important good credit is, and we can help make your life easier by helping you get better credit.