Your unrelenting debt load has caused you pain and suffering, and you need a solution – fast. You’re considering a financial strategy called debt consolidation, but you aren’t sure what that is. Here’s a primer that could help.
Debt Consolidation
Before you weigh the costs and benefits of debt consolidation, you need to understand what such a loan is. In a nutshell, it’s a form of debt refinancing that entails taking out one loan to pay off multiple others. Your new loan will usually have favorable terms in the form of a lower interest rate or monthly payment than what you’re now paying, or both.
For example, as the York News-Times cites, if you have $9,000 in debt with a combined annualized percentage rate (APR) of 25 percent and a combined monthly outlay of $500, you’ll pay $2,500 in interest over some two years. However, if you got a debt consolidation loan with a 17 percent APR and two years to repay it, your new monthly payment would be $445. The $820 you save on the lower monthly payment could help you pay down your new loan.
Upside
When sorting through the pros and cons of debt consolidation, also consider pros and cons of debt consolidation a loan could net you a better credit score. What’s that, you say? Well, if you have maxed out your plastic your utilization ratio will be quite high. Erasing credit card debt with a loan will lower card utilization – one of the biggest factors determining your score.
In addition to offering potentially lower monthly rates or payments, debt consolidation also streamlines debt management. If you have multiple credit cards, for example, you may find it hard to keep track. With a debt consolidation loan, you need only make one monthly payment, and for the same amount each time.
According to a Lending Club study, those who used a loan to pay off debt experienced an average score increase of 21 points within three months of loan approval. The ideal way to improve your credit score is to eliminate your credit card burden.
Down Side
One risk of consolidation is that, once you pay off your credit cards, you have loads on newly available credit. It’s tempting to run up more debt. If you fell into debt because of credit card use, generating more spending power could be fraught. So, make sure you’ve changed your spending habits before you commit to a new loan.
You also may not be eligible for a balance transfer card, which usually requires a credit score of at least 690. Such cards typically offer zero interest during a promotional period, which can last up to 18 months.
Compared with a promotional card it is somewhat easier to get a debt consolidation loan, some of which are aimed at applicants with credit scores of 629 and lower. Still, people with the best scores tend to get the best interest rates. If the lender can’t offer a lower rate than what you’re paying aggregately on existing debt, consolidation typically isn’t a good idea.
Another hazard is that you could fall behind paying off your new loan and wind up in a worse position than when you started. You could accrue late fees, and the missed payments will be reflected on your credit report.
Before signing off on a consolidation loan, be sure that the new monthly payment will be manageable for you throughout your repayment period.
So, now that you know the costs and benefits of debt consolidation you can make an informed decision about your financial future.
HussaiN is a full-time professional blogger from India. He is passionate about content writing, tech enthusiasts, and computer technologies. Apart from content writing on the internet, he likes reading various tech magazines and several other blogs on the internet. Email ID: [email protected]
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