Pros and Cons of Consolidating Debt
Tackling your debt is one of the most important steps to getting your financial life under control and reaching big money goals. While it can seem complicated or even disheartening at times, paying off your debt is possible, especially with a solid game plan. That’s why many people choose debt consolidation when paying off debt.
Debt consolidation can be a great tool to conquer your debt, but it’s not for everyone. Here’s what to know about consolidating your debt before you take the plunge.
What is debt consolidation?
If you have multiple debts — such as several credit cards or loans — it can be helpful to consolidate all the debt into just one payment. You can do this by taking out one loan that’s big enough to cover all of your outstanding debt. Then, this loan is used to pay your individual credit cards or prior loans so you can focus on simply repaying the new loan.
In order to get a debt consolidation loan, lenders are typically going to want to see that you have “fair” credit or better. That means if your credit score is below 580 you might find it difficult to get approved for a debt consolidation loan.
Related reading: Top 10 Ways to Improve Credit Scores
Advantages of debt consolidation
Debt consolidation can be a savvy financial move if you find yourself in the right circumstances to take advantage of what it has to offer. Here are some of the benefits of consolidating your debt.
Debt consolidation can simplify your repayment process. Instead of focusing on multiple loans or credit cards with different payment due dates each month, you only have one loan and due date to remember.
If your credit has improved since you first obtained some of your original debt, you might qualify for a lower interest rate with your new loan. This can save you money in interest payments when paying off debt.
If you’re struggling to keep up with the monthly payments on some of your current debt, you can opt for a longer term on your consolidation loan to help make your monthly payments smaller. However, you’ll pay more interest overall by taking this approach.
It can be confusing to figure out how to get out of credit card debt. A loan with a clear repayment schedule and terms might be easier to get a handle on and stay committed to repaying.
For people who have frustrations with their current lenders, consolidating debt with a new lender gives them a chance to compare other lenders and find a better match.
Disadvantages to consolidating your debt
Debt consolidation isn’t always the best strategy. There will be times where it’s better to find a different solution to tackling your debt. Here are some caveats to consider before deciding to get a debt consolidation loan.
If your current loans have prepayment penalties, it might cost more to repay them with the debt consolidation loan than it would to keep making your scheduled payments.
There could be fees associated with the new loan, such as origination fees, that make it more expensive.
If your credit has worsened since you took on your original debt you might not qualify for a comparable interest rate so a new loan might be more expensive.
Many debt consolidation scams offering “debt relief” take advantage of people who are working through their debt. If you’re thinking about using a paid debt consolidation service, do your due diligence by researching all of the fees associated with it. It’s likely easier and cheaper to do it yourself.
Also, as you’re repaying your debt through consolidation, make sure you stop using credit cards after they’re repaid. Often people are tempted into old overspending habits using their credit cards and they actually end up in more debt than when they started.
Consolidating your debt isn’t a magic bullet to repair your finances. You have to be willing to put in the work to either reduce your spending, increase your income or both in order to successfully change your financial situation.
What to look for in a debt consolidation loan
If you decide to get a debt consolidation loan it’s best to compare lenders online to make sure you get the best rate possible. Ensure that lenders are doing a soft credit pull to quote you rates so that your credit isn’t impacted. Here are several ways to compare debt consolidation loans between lenders.
The interest rate refers to the percentage the lender will charge you on the principle of the loan. Some lenders might be able to offer you better interest rates if you have a previous banking relationship with them.
The interest rate isn’t the only way lenders make money on your loan. You should also pay attention to any fees associated with borrowing the money. This could include an origination fee, prepayment fees or even late fees.
The term of the loan will also help determine the monthly payments that you’ll owe. With a longer term you’ll have lower monthly payments but end up paying more in interest over the lifetime of the loan. Make sure you compare the repayment terms offered to you and if they’ll fit into your monthly budget.
Adding a cosigner to your loan could help you get approved for a higher dollar amount or a better interest rate, but not all lenders allow this. If a cosigner is part of your debt consolidation strategy, be sure to factor this into your research. It could end up disqualifying a few lenders from the very start.
Lenders occasionally add extra benefits and services into their offerings to make themselves more competitive to consumers. These occasionally include advantages, such as financial counseling, flexible payment dates, an interest rate discount if you sign up for auto-pay or even unemployment protection to help you pause payments if you lose your job. Check with each lender to see if they offer any added benefits.