What Is Debt Consolidation, And Does It Make Sense For You?
3-Minute ReadJune 06, 2022
Are you trying to repay multiple high-interest debts? If so, you may find it difficult to manage the varying payments, interest rates, payment dates and payback periods.
That’s where debt consolidation comes in! Debt consolidation is a strategy you can use to combine multiple bills into one easy-to-manage payment. With debt consolidation, you can simplify the repayment process and even save money on interest.
What Is Debt Consolidation?
When you consolidate debt, you combine multiple payments, such as medical bills, credit card debt and payday loans into one single payment. Debt consolidation, also known as bill or credit consolidation, can make it easier for you to manage multiple debts while giving you the opportunity to secure lower interest rates and lower monthly payments.
How To Consolidate Your Debt
Debt consolidation loans, balance transfer cards and debt settlement are all examples of strategies you can use to consolidate your debt. Since each strategy has its pros and cons, it’s a good idea to review your options and choose the one that best fits your budget and lifestyle needs.
Debt Consolidation Loan (Personal Loan)
Consolidating your debts into a personal loan from a bank, credit union or online lender may make sense if you have multiple high interest debts. Ideally, your personal loan will come with a lower interest rate than all, or at least most, of your high interest debts.
It’s important to note that personal loans require a certain credit score, and you’ll likely need a good or excellent score to achieve a lower interest rate. So, if you don’t have the best credit, a personal loan may not be the best option.
Balance Transfer Cards
When you use a balance transfer card, you’re essentially transferring your existing debts onto a new credit card with a promotional interest rate that can be as low as 0%. Keep in mind, there are some drawbacks to this method.
If you go this route, you’ll likely have to pay a balance transfer fee, which will be 2% to 5% of your total balance. Also, once the promotional interest rate runs out (in about a year), you’ll be left with a much higher interest rate that may rise as much as 14% to 26%. Compared to a personal loan, a balance transfer may offer more risk than reward.
Debt settlement differs from debt consolidation loans and balance transfer cards in that it involves negotiation. Some may hire a company to negotiate with your creditors and convince them to settle your debts for less than what you owe.
Here’s how this process typically works: You deposit money every month into a special account. Once your balance reaches a certain amount, the debt settlement company will reach out to your creditors and negotiate a lower settlement amount.
The downfalls to debt settlement are that you’ll have to make monthly payments, your credit score will take a hit, and you’ll be charged a fee by the debt settlement company, which will likely be 15% to 25% of your total enrolled debt.
When Should You Consolidate Your Debt?
If you feel overwhelmed by multiple debts and can simplify them into one monthly payment with a lower interest rate, debt consolidation may be the ideal way to go. It can also be a good move if you can qualify for the 0% interest balance transfer card and are confident that you’ll be able to pay off your debt during the promotional period.
Things To Consider Before You Consolidate Your Debt
Debt consolidation does not address the initial cause of your debt or make it magically disappear. Instead, it is a simple financing tool that can help you manage your debt and its payments. Therefore, if your debt is the result of careless spending, you can’t count on it to improve your financial situation.
Also, if you don’t have too much debt and believe you can pay it off fairly quickly, keep in mind that debt consolidation may not be worth it.
Will Debt Or Credit Consolidation Affect My Credit Score?
Debt consolidation has the potential to help or hurt your credit score, but your score hurts more when you don't take action toward your initial debt. You can improve your credit score with debt consolidation if you make on-time payments every month, eliminate or reduce your balances and change your spending habits so that you don’t take on more debt.
It may take a toll on your credit score if you make late payments, continue to charge your credit cards after you’ve paid off your balances and apply for many loans in a short period of time.
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