A debt consolidation loan allows you to pay off your current debts with a new loan that has different terms than your current loans/ credit cards. Whether consolidating your debt is a good idea or not depends on your personal financial situation and the type of debt consolidation your considering.
How is this type of loan helpful?
If you have extremely high interest rate on your credit cards, your debt may grow faster than you can pay it off. A debt consolidation loan may allow you to get a lower interest rate, which would save you money in the long-run.
You may also struggle with high minimum payments which are sometimes more than you can afford to pay each month. If you miss payments because they are higher than you can afford, your interest rates go up. A consolidation loan can sometimes lower your monthly payment.
If you have many bills, you may find it harder to keep track of which payment is due on which date. Consolidation can help with this problem by reducing the number of bills you get down to a single one. That can make it easier to focus on getting out of debt.
Is a consolidation loan the best option for me?
There are a wide range of options when it comes to debt consolidation loans. Each have advantages and disadvantages. The best thing is to do your research and understand how each option works.
Debt Consolidation Company
Pros:You owe the debt consolidation company an amount equal to the total sum of all your debts. And you will pay a monthly payment to them, which will go toward paying the principal of the loan as well as interest and fees. If you can get a low interest rate, this may be a good option.
Cons: Once you have agreed to the debt consolidation plan, you can’t go back, so it’s important to understand the potential consequences first. The fees and interest rates can end up being very high – especially if you have fair or poor credit. Since most people struggling with debt do not have excellent credit scores, they’ll have to pay high interest rates and fees which will burn a large percentage of their total cash flow each month.
Home Equity Line of Credit
Pros: Home Equity Line of Credit (HELOC) allows you to borrow money against the value of your home. The size of these loans vary. While home equity loans usually have fixed terms, HELOCs allow you to apply for a credit limit that you can draw upon at your convenience but there’s no guarantee that your interest rates will stay the same.
Cons: While a home equity loan or HELOC can provide a lower interest rates than other loan types, but if you stop paying your mortgage, your house serves as collateral, so the bank could take your house.
Balance Transfers
Pros: Balance transfers are a way to consolidate your debt onto one card. You initiate the balance transfer and pay an immediate transfer fee. Then you have 6 months to a year that you won’t accumulate interest on the balance.
Cons: If you miss or make a late payment, you will often lose the introductory 0% interest rate and will have to start paying interest immediately.
Each person’s financial situation is different. You have to understand your financial position first or you can end up choosing a debt solution that you cannot afford or commit to. Consider your options carefully before applying for any kind of loan. Debt consolidation will not really solve your problem, only make it easier to pay off your loan.
To avoid the pitfalls of debt consolidation loans, make sure you:
- Borrow only what you need
- Understand the terms of the new loan
- Commit to a repayment plan
- Stop using more credit
When is debt consolidation a BAD idea?
You have to discipline yourself and commit to paying off your loan. If you don’t think you have the self-control to pull this off, opt for debt management instead. A lower monthly payment means stretching your balance over a longer payment period. Even with a lower interest rate, you will end up paying a lot more on the loan. If you want a lower monthly payment, consider debt settlement.
