27 May Is Debt Consolidation a Good Idea?
Consumer debt is a big problem in the United States. We are talking $14.1 trillion big.
With Americans carrying an average personal debt of $90,460, according to Experian’s 2019 Consumer Debt Study, it makes sense to explore debt consolidation as a solution to relieve the debt burden.
These debt figures include retail cards and credit cards, mortgage loans, home equity lines of credit (HELOCs), personal loans, and student loans.
According to the Institute for College Access and Success, the average student loan debt for the Class of 2018 is $29,200, a 2% increase over the prior year .
This makes student loans the second-highest consumer debt category–only behind mortgage debt.
Essentially, 44 million Americans are struggling to pay off their education.
More than student loans as a source of debt are credit cards.
Debt.org shares that each household with a credit card carries on average $8,398 in credit card debt.
If you’re one of the 80% of Americans dragged down by debt, you’re likely looking for the smartest and fastest way to get out from under it.
Consolidating your debt could be a useful solution–but, is it always a good idea?
The short answer is that it’s not the answer for everyone.
There are definitely factors to consider. Your financial situation and the type of debt consolidation you decide on will determine the kind of success you have eliminating what you owe.
Examining the types of consolidation and the pros and cons of each will help determine if debt consolidation is a good idea for you.
Pros of Consolidating Debt
If you hold several credit cards with large balances, and you find it challenging to make even minimum payments, debt consolidation could be a viable ticket toward financial freedom.
Some of the benefits of consolidating include:
- Convenience. Consolidation simplifies your finances by reducing the number of payments you make monthly. This limits the chances of accidentally forgetting one of your bills if you have multiple credit cards.
- Less Risk. Having fewer payments to make each month reduces the likelihood of being late on payments and tacking on additional fees to your debt.
- Lower Payments. Debt consolidation is especially effective on high-interest debt, such as credit cards. It may reduce your monthly payment by lowering the interest rate, making it easier to pay off the debt.
- Get Debt-Free Faster. If you can consolidate your debt to a lowe- interest personal loan, you’re in a much better position to get out of debt faster.
Cons of Consolidating Debt
Debt consolidation isn’t without its risks. While offering a sensible solution to those overwhelmed by debt, there are downsides to consider.
- Increase in Total Interest. If you consolidate with a loan, you might pay more in total interest since the low interest rate does not stay low forever. Oftentimes, having a low rate can prolong the time it takes to pay off the debt.
- Impact on Credit Score. Normally, debt consolidation, in whatever form, will almost always have a negative impact on your credit score. Loans and balance transfer cards require a hard inquiry on your credit, which can ding your credit score by a few points.
- False Sense of Security. Paying one lower monthly payment through debt consolidation might offer emotional and financial relief. However, this could also give you a premature confidence around your financial situation. Letting your guard down could lead to incurring additional debt before you have paid off the consolidation loan. Hence, the cycle starts all over again.Debt consolidation is not a quick fix to debt woes.
It requires commitment, strategy, and changes in spending habits. With this in mind, here are several good options to tackle your credit card or student loan debt.
4 Ways to Consolidate Unsecured Debt
Unsecured debt is what you owe on credit cards and personal and student loans. With this type of debt, the lender does not have any collateral to take back in case of nonpayment.
This is why the interest rate is almost always higher.
There are four ways to consolidate unsecured debt without tapping into your retirement, savings, or putting up collateral.
#1 Transfer Balances to Single Credit Card with Lower or 0% Interest
When you’re faced with interest rates as high as 25%, an invitation to a credit card with lower rates or even 0% is pretty hard to pass up.
If you have a great credit score and not a lot of debt, a balance transfer could be the cheapest consolidation option—even if you’re able to qualify for a personal loan.
A balance transfer card lets you combine other credit card and loan debt onto one card and pay no interest on that balance transfer during the introductory period.
The 0% promotional rate won’t last forever though.
Introductory offers range from around 12 to 21 months in most cases.
Once expired, the interest rate will rise–most times way above what you’d pay for a personal loan.
Remember that companies offer rates as low as 0% as an incentive to win new customers.
While tempting, consider other debt consolidation options If you can’t pay off your debt within the promotional interest time frame.
#2 Borrow from Family or Friends
There certainly are some advantages of looking to family or friends for a personal loan to consolidate your debt.
For one thing, you don’t have to be put through the approval ringer.
People who know and care about you want to see you reach your financial goals, so they are more likely to lend without a deep financial-history investigation.
There can also be flexibility when it comes to repayment schedules. Should you hit a challenging patch, family and friends may be more open to halting or adjusting payments for you.
Finally, there is the big benefit of arranging a much lower interest rate than a credit card company.
This speeds up the time of repayment getting you closer to financial freedom quicker.
It’s important to have structure around a loan from a family member or friend. Having a contract in place delineating monthly payments and what happens in case of late payment is key.
It not only creates an energy of commitment to repayment, but also maintains the integrity of your relationship.
This type of debt consolidation works if you’re confident about holding up your part of the contract and are okay with loved ones being privy to your financial status.
#3 Work with a Nonprofit Credit Counseling Agency
Nonprofit credit counseling agencies offer individuals financial guidance, including debt management, student loan counseling, and credit counseling.
Debt management is a form of debt consolidation whereby the credit counseling agency, advocates for you when dealing with your creditors.
To make payments more affordable for you, they make agreements to lower interest rates if you’re qualified. You then make one payment to the credit counseling agency and they distribute the money to your creditors.
Here are the pros of this type of debt consolidation:
- Since this is not a loan, there is flexibility. You can pay off your debt or choose to withdraw from the program. Just know you will lose any advantages on interest rates and late payments if you withdraw.
- You get mentored by your credit counselor who offers useful suggestions to avoid falling into debt again after you complete the management plan.
- Paying your debt through a plan takes less time than a self-managed plan. Typically, it takes 3 to 5 years to settle your debts completely.
Here are the cons of this type of debt consolidation:
- There is a monthly fee charged for managing your plan, which is included in your monthly payment.
- Almost always, you are required to close all credit card accounts in the program while participating in the management plan. Sometimes you are allowed to keep one credit card, but only for emergencies.
- If you miss a payment, the concessions on interest rate/late payment fees made when you started the program can be cancelled.
- During the first 6 months of the debt management plan, your credit score will dip a few points. As long as you make payments on time consistently, it will recover and even improve over time.
#4 Take Out a Personal Loan
Personal loans are another way to consolidate credit card debt by turning multiple balances into a single monthly payment.
These loans, which don’t require collateral, are available through banks, credit unions and a variety of online lenders.
Most lenders will allow you to shop for an interest rate without hurting your credit score.
Personal loans mostly benefit those with high credit scores. If you score less than 600, you can likely expect to pay high interest rates, which makes this option not worth it.
If you have good credit, however, a debt consolidation loan offers a low interest rate, which has many benefits.
By paying less monthly, you can make loan payments on time and may also have more money to throw at your balance. This results in reaching your goal of paying off your debt faster.
Before signing onto a personal loan to pay off student loans or credit cards, make sure to consider the interest rate offered and the repayment terms.
A longer repayment term could cost you more in interest as you pay off the original credit card debt. However, this could be worth your while if it helps you afford to repay the debt and protects your credit from the repercussions of missed payments.
Keep in mind, too, that lenders often charge origination fees for personal loans.
NOTE: We do not recommend borrowing against your retirement savings (IRA or 401(k) to pay off debt. Tax and penalties aside, doing this may severely limit your ability to retire with enough money.
Debt Consolidation Tips
- Get to the root of the problem. Even if you manage to consolidate and pay off your debt, ignoring your habits can actually invite the cycle to reoccur. A financial advisor or money management app can act as guides to evaluate your spending and offer ways to change money-related behaviors.
- Do the math. Make a point to sit down and write out EVERYTHING you owe, including the interest you’re paying on each debt. Create a list or spreadsheet and get the big picture of where you really stand financially. Seeing it written will give you a true layout of where to start. There are several online debt consolidation calculators that can help you get started.
- Decide on the right debts to consolidate. You’re better off consolidating your high-interest debts. Leave the low-interest, low-balance debts to pay off separately. It may sound reasonable to transfer an already low-interest student loan to a temporary 0% credit card, but there’s more to it than that. Factor in the balance transfer fee, and remember that it jumps to a double-digit interest rate if you don’t pay off the debt within the promotional period.
- Research your options. Dive into a deep search for the best consolidation plan for you. Once you’re clear on your outstanding debts, shop around for interest rates. It can be worth your time to call your creditors to negotiate a lower rate. Crunch those numbers and make a list of all your options. Be clear on the implications of new loans should you take that route to consolidate. Keep your eye on the overall payment—the last thing you want is to be paying more in interest.
- Commit to a method and work the plan. Regardless of the way you decide to pay off your debt, it is imperative to have and stick to your chosen method. Look at your spending habits and see where you can make changes. Create a budget that balances your income with your spending and savings goals. If you need support, consider using a budget management app or working with a financial counselor. If you organize your debt, stick to the payment plan, and commit to a timeline, you will find yourself on the road to financial freedom.
- Refrain from using your credit too soon. As you see your debt amount dwindle, remind yourself that this is not an invitation to start spending again. To avoid temptation, have only one credit card you use for emergencies and place the others out of sight.
Debt consolidation can be an attractive way to attack your looming debt and give you access to needed money.
But, going that route should only be considered when it’s affordable and makes financial sense.
Before you opt for your type of debt consolidation, make sure you can afford the payments.
Do your research, read the fine print from lenders, and lay out all possible ways to reduce what you owe.
Being proactive in finding the best debt consolidation options can save you from falling deeper into debt and help you attain your financial goals.
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