Debt consolidation is the process of paying off multiple existing debts with a single new loan. While there are specific loans marketed as debt consolidation loans, personal loans and home equity loans can also be used to consolidate debt.
Reasons for Debt Consolidation
The first step in determining if debt consolidation is right for you is to assess your goals. Borrowers may consolidate debt for several reasons, including:
– Reducing overall interest costs: If you qualify for a new loan with a lower interest rate and don’t significantly extend your repayment term, you may save money on debt repayment.
– Lowering monthly payments: Your monthly payment may be lower as a result of consolidation if you reduce your interest rate, extend your repayment term, or both.
– Simplifying the repayment process: When you pay off multiple existing debts with a single new loan, you’ll have just one payment to worry about instead of many payments. This may be easier to manage.
– Changing loan providers: If you’re not satisfied with your current loan providers, debt consolidation allows you to switch to the new loan you will be dealing with for all future payments.
Types of Debt That Can Be Consolidated
You can consolidate many types of debt including:
– Credit card bills
– Medical debt
– Personal loan debt
Note: You can also consolidate private student loans and federal student loans, but consolidating federal student loans is a more complex process than refinancing to a private student loan or applying for a personal loan.
Alternatives to Debt Consolidation Loans
Debt consolidation is not the only solution for changing your loan terms. You can also:
– Negotiate the terms of your current loan
– Refinance
– Balance transfer
– Debt management plan
When Is Debt Consolidation Right for You?
Debt consolidation may be a good fit for you if:
– You qualify for a consolidation loan: Generally, you will need good credit and proof of income. If you can’t qualify based on your own financial profile, you may need a co-signer.
– You can reduce the interest rate on your existing loans through consolidation: Generally, you shouldn’t take out a consolidation loan at a higher rate than your existing debts, as it will increase repayment costs in the long run due to higher interest.
– You can afford the new monthly payments on the consolidation loan: You don’t want to borrow money if you are going to struggle to make the monthly payments.
– You have a strong financial plan: If you do not have a sustainable financial plan, debt consolidation may be risky if it only makes you feel like you’re making progress on your debt when you’re just moving the balance to another place. It’s also risky if you lack control over your spending and your debt deepens again once the consolidation loan’s credit frees up.
– You understand the total repayment costs on the consolidation loan: Don’t just focus on lowering the monthly payment – loan costs can increase in the long run even with a lower payment if you extend your repayment term.
Note: Some debt consolidation loans may have high fees or prepayment penalties. These expenses should be avoided as they can increase repayment costs.
If you are considering taking out a home equity loan, a home equity line of credit (HELOC), or a cash-out refinance to consolidate debt, you should be aware that you may be turning unsecured debt (like credit card debt or personal loans) into secured debt.
With secured debt, the asset – in this case, your home – acts as collateral and can be lost if you cannot repay what you borrowed. On the other hand, unsecured debt is not backed by any assets, so if you default, you typically won’t risk losing your home (although your credit will be impacted). Since you are putting your home at risk by borrowing against it to consolidate debt, you should make this choice carefully.
Conclusions
Home
Debt consolidation can make repayment cheaper if you qualify for a lower interest rate than you are currently paying and do not significantly extend the repayment term. You will need good credit and proof of income to qualify for a competitive debt consolidation loan. You do not have to use a debt consolidation loan specifically to consolidate your debt – any personal loan should work. Be cautious when converting unsecured debt – such as credit card debt – into secured debt like a home equity loan; as this puts your assets, such as your home, at risk.
Source: https://www.thebalancemoney.com/is-consolidation-a-good-option-for-me-2385875
Leave a Reply