Americans had done a better job of avoiding debt over the past decade, compared to the levels of personal debt seen before the Great Recession. But that scenario is changing.
American adults accumulated a total of $ 1,029 trillion in credit card debt as of the end of 2017, according to the Federal Reserve. This amounts to $ 8,732 per American household, reports the federal government. Worse yet, far too many credit card customers pay high interest rates – often 20% or more.
With credit card debt so high and student loan debt soaring, one way to get on the road to financial recovery is to take out a debt consolidation loan.
These loans can save the day for Americans facing high debt, if they properly handle the consolidated loan process.
On the other hand, since debt consolidation is essentially a refinanced loan with longer repayment terms, you will likely be in debt longer than before the consolidation, unless you can repay the loan aggressively.
Let’s take a look at debt consolidation and see how it can help you get out of substantial household debt, and what risks can arise if you don’t take a diligent approach to managing debt with a loan. consolidated.
What is debt consolidation?
With debt consolidation, consumers of personal financial services can take out only one large loan (i.e. loans, auto debts, medical debts, and personal loans.
It does this by consolidating all these household debts into one monthly bill, which theoretically facilitates its management, in a single payment and ideally at a relatively low interest rate. Essentially, debt consolidation is all about funneling all of your monthly debt into one loan and using that money to pay it off, leaving only one consolidated loan to manage.
Consolidation isn’t just about taking out a loan, although it is a very common method of dealing with widespread personal debt.
With debt consolidation programs, you basically consider two options: credit cards with balance transfer or a fixed rate debt consolidation loan:
- A low or no interest balanced credit card. Here, you transfer all of your debts to a credit card, with the aim of paying off the debt transferred during the promotional period of the card.
- A consolidated fixed rate loan. This type of loan allows you to access a large amount of loan money, which you can immediately use to pay off your household debts.
Pros and Cons of Debt Consolidation
Like any personal financial tool, debt consolidation has its pros and cons, and it is imperative that a financial consumer understands where consolidation is helpful and where it isn’t.
These “pros and cons” can help clarify matters:
Benefits of debt consolidation
1. Pay off many debts faster
With debt consolidation, you can clean up multiple financial debts quickly and efficiently, saving both money and time in the process. The main money-saving feature is usually paying a lower interest rate on a consolidated loan or zero rate credit card, compared to the higher interest rates associated with traditional credit cards, loans personal and student loans.
Lower interest rates have a ripple effect on high personal debt:
Since you are paying a lower interest rate, you are investing more money in the principle of paying off the debt. For example, using a consolidated loan with an 8% interest rate against thousands of dollars in credit card debt with an interest rate of 16% allows the borrower to save substantial money on in the long term, if he used the consolidated loan to pay off strictly other debt with a higher interest rate.
2. You simplify the debt repayment process
The term consolidation means bringing together several things into one package and that is exactly what loan consolidation can do. Instead of having to keep up with six or seven different credit and loan accounts that required monthly payments on time, you only have one payment to make with a consolidated loan.
It’s much easier to manage your debt with just one payment, as opposed to half a dozen payments, resulting in fewer missed payments, saving money on late fees and rates. higher rates that often accompany missed or late monthly payments.
3. You will bring a positive charge to your credit score
Another benefit of consolidating your debt into a single monthly loan payment is that you stay well ahead of potential credit problems. With multiple monthly payments, you could easily miss a payment and fall behind. Missed payments, however, have a significant impact on your FICO credit score – 35% of which is calculated by making monthly credit and loan payments on time.
By making your loan payment on time, you’ll improve your FICO score – without damaging it.
Disadvantages of Debt Consolidation
1. You will always have a monthly debt to pay
Although debt consolidation loans can pay off a wide range of smaller monthly debts, you will have more monthly debt to pay off and you cannot afford to miss payments. This is because you are exchanging a series of smaller payments for a larger, newer form of debt – which has to be serviced each month, and at a repayment amount that might be intimidating at first.
2. If you don’t do the consolidated loan, your financial problems will get worse
In theory, consolidating your matching monthly loan debts into one easy payment is a good idea. In reality, if you don’t make the much larger consolidated monthly loan payment every month and on time, you might have to pay late fees and higher interest rates which will only make your mortgage problem worse. indebtedness.
3. Consolidated loans often come with high user fees
It is common for consumers to be surprised, and not in a good way, by the high fees that can be attached to consolidated loans from banks and lenders. For example, some loan origination fees, which are added to the overall cost of the loan, can be as high as 8%. On a loan of $ 10,000, this could mean adding an additional $ 800 in fees. Be sure to check with your lender to avoid or reduce loan fees.
Five debt consolidation tips for 2019
Use these tips to get the most out of your debt consolidation experience:
1. Do you have good credit? Use a credit card balance transfer
If you have a solid FICO credit score of 700 or higher, your best bet might be to avoid a consolidated loan from a bank or lender and focus on a credit card balance transfer instead.
The idea here is to transfer all of your monthly debt to a low or no interest balance transfer credit card. Be on the lookout for steep balance transfer fees, but if you get the job done right, you can get a zero rate balance transfer card for up to 24 months. It’s a good deal, and one that can save you a lot of money, as long as you pay your card bill on time.
2. Think twice before using a home equity loan to consolidate your debt
While a low interest home equity loan is an option when consolidating debt, it does come with risks. Since a home equity loan is attached to your mortgage, you’re probably putting the biggest personal financial asset you own – your home – at great risk if you don’t keep up with your home equity loan payments.
3. Beware of debt settlement programs
If you choose to hire a debt settlement company to handle your personal debt problems, do your homework and consider any company you are considering hiring.
By definition, a debt settlement company will negotiate a lower overall payment for your debt and charge you a large fee – often several thousand dollars prepaid – with no guarantee that your debt problem will go away. Better to give debt settlement companies more space and focus on a do-it-yourself debt consolidation campaign using a loan or credit card with balance transfer.
4. Improve your credit score
The point is, loan consolidation options only work if you can get them with a good credit score – that’s what allows you to get the low interest rates needed to save money and pay off. loans faster.
Therefore, it is a good idea to resolve any credit score issues, clean up errors on your credit report, and increase your credit score before applying for consolidated loans or balance transfer credit cards. .
5. Apply financial deals to household debt payments
There is no law that says you have to take a work bonus or a family heirloom and spend it on a new SUV or a trip to Italy.
Instead, take this windfall and apply it directly to household debt; this will help you pay off your debt faster.