You’ve likely considered debt consolidation if you owe over a thousand dollars on credit cards with high interest rates. What is debt consolidation, and how does it function? When is debt consolidation a good strategy and when not?
We’ll look at the basics of debt consolidating to help you determine when it is the right thing to do and when it could make your situation worse.
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Debt Consolidation Guide
What is debt consolidation?
It is a way to wrap up two or more credit cards or loans into one loan. If you are wondering what to do to get rid of debt, this is one of the most effective strategies. It’s a great first step for many couples and individuals.
It’s important to know that a consolidation of debt does not reduce your debt. It merely repackages the debt into a more manageable one.Ask a CFP (r) about 4 MUSTS for your next student loan
This alone is a great way to eliminate debt. It is easier for many debtors to make a single payment per month on one loan than to pay multiple monthly payments on different obligations.
In a traditional debt consolidation scenario, not only are you consolidating your debts into a single loan but you also want to lower your monthly payments. This is possible if you can obtain a loan with a lower rate of interest than the debts that you are consolidating.
Another advantage is to convert revolving credit, such as credit cards, into a installment loan.
Credit cards are notorious for their revolving balances. Despite making payments, your balance never decreases. This is due to the combination of high interest rates, often above 20%, and continued use of credit cards for new purchases.
You may be able pay off your debts in as little as three to five years with a debt consolidation loan. Credit cards, on the other hand, tend to be a permanent debt. Consolidating your debts is one way to stop this.
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How does debt consolidation work?
Say you have unpaid balances on 5 credit cards. Five credit cards have a total balance of $20,000. The average interest rate is 24%.
You pay about $500 per month, or 2.5%. Of that $400, only $100 is for principal reduction. If you continue to pay your credit card debt at this rate, it could take you a minimum of 12 years before the balance is paid off.
Consolidation of debt is an option. You can pay off your five credit cards with a $20,000 loan. Five years at 8% interest. This will give you a payment of $405.53 per month.
You will not only be able to pay off your credit cards faster, but also save money. The peace of mind you get from knowing that in five years, your debt will be gone is enough to justify debt consolidation.
You’ll save money on interest by consolidating your debt. The monthly interest rate will be $133.33. You’ll save a third of what you pay on credit cards.
A personal loan is the best way to consolidate debt. To do this, you will need to understand and how to get your personal loan approved. You can now apply for many personal loans online.
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What are the pros and cons of debt consolidation?
- Consolidate multiple loans and credit cards into a single loan with a single monthly payment.
- Convert variable-rate credit card into fixed-rate loan
- You can save thousands of dollars on interest.
- You can get out of credit card debt in 3 to 5 short years.
- See the next section to learn how you can improve your credit score.
You can also find out more about Cons
- Credit scores of average or higher are generally required, particularly for large loan amounts.
- You may not be able to save much interest with fair credit.
- It doesn’t eliminate the debt immediately, but it repackages them into a single mortgage.
- You could end up in even more debt if after you secure the debt consolidation, you continue to borrow.
Some debtors are known to consolidate debts in a serial manner, converting one consolidation loan into a larger one.
You can consolidate your debts and improve your credit rating
Unexpectedly, debt consolidation can also improve your credit score. After consolidating their debts, many borrowers saw a 20-30 point increase in their credit score almost immediately.
This improvement in credit scores is due to the new way that credit scores are calculated.
The calculation is based on two factors: 1) the number and type of outstanding accounts, and 2) the ratio between revolving debt and installment debt.
You can reduce multiple credit lines to just one by consolidating your debt and paying off credit cards. This alone will add a few credit points to your score. You’ll gain a few points by switching from revolving to installment debt. Credit bureaus prefer installment loans because they are more predictable, particularly in terms of interest rates.
It’s not the end. Your credit score will rise as you continue to make on-time, regular payments for the debt consolidation.
Consolidating your debts can be a good way to improve your credit score if you need it.According to Experian The largest of the major credit bureaus has a breakdown of credit scores that looks like this.
As you can see from the table, good credit begins at 670. If your credit score is low, you might need to work with one of the top credit repair companies to get your score back up to where you want it to be.
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What to do if you are in need of debt consolidation?
It is not a good idea to take out a debt consolidation loan without considering your financial situation. First, you’ll need to consider your financial situation. Then ask yourself: Should I consolidate my debt ?
Consolidation of debt is a good idea if you meet any of these criteria:
- You can obtain a loan large enough to pay all of your debts if you have a high income and credit rating.
- You can benefit from a lower rate of interest than what you are currently paying for your debts if you have a high credit score.
- Your monthly payments will be less than your total debts.
- You’ve set up a budget and are able to live within the limits of your income.
- You are committed to getting rid of your debt. Once the loan has been approved, you’re ready to stop taking on new debt.
Consolidation loans may not be a good idea if you meet any of these criteria:
- You can’t get enough money for a consolidation loan to pay all of your debts.
- If your credit rating is poor or fair, you won’t be able to save on interest rates.
- Your monthly payments for a debt consolidation loan could be higher than your combined payments of all current debt.
- It’s possible that you haven’t set up a budget and are unsure if you can still live within your means after consolidation.
- You and your spouse are not prepared to stop using credit cards in the near term.
Debt relief may not be the best solution for all of your debt issues, but it can work well for some consumers.
A Debt Relief Program may help you reduce your debt if you have more than $15,000 in debt. It will also make it easier to manage.
Debt Consolidation Questions
What is debt consolidation?
Consolidation is the key word when it comes to debt consolidation. The debt is not eliminated, it’s just combined with your other loans and credit cards into one loan.
If you can consolidate all of your debts in one loan, it will benefit your finances. You will need to qualify for a lower interest rate than you currently pay on your debts. The monthly payment must be lower than your current combined payments.