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How to Determine if Debt Consolidation is the Right Choice for You?

How to Choose Debt Consolidation

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There are many caveats about whether to consolidate your debt. Due to the high-interest rate, it may not be easy to repay the existing loan on time. For this, you need to limit the range of your needs or spend a dozen years on repayment. 

At what point can you say that debt consolidation is a smart idea? Below, we will tell in more detail how debt consolidation works and what are its advantages and disadvantages. Additionally, we will focus on the most evident signs of when you should consider such a debt payoff method. 

What is Debt Consolidation?

Debt consolidation is a new personal loan issued to pay off several existing debts. Borrowers take it to simplify the process of repayment of several existing debts. In this way, all your monthly payments are combined into the single one that has a lower interest rate. 

You can consolidate debts in different ways. Some services offer a specialized debt consolidation loan. Generally, any standard loan will fit this function because the main task is to get the money you will send in the direction you want. 

Alternatively, you can move the existing debt to a new credit card. Such a card usually provides borrowers with a 0% annual percentage rate APR for six months. Sometimes this condition can remain valid for two years. The clients can specify the debt sums they wish to transfer when they open the card. This can also be done after the supplier registers the balance transfer credit card. 

How Does It Work?

The main principle is to combine all the debts you have into one. At the same time, you need to take into account the conditions for receiving a new loan. Usually, you will be able to get a new cash advance at a lower interest rate. It will help you to pay off the previous ones faster.

The procedure of debt consolidation requires the following steps:

  • Choose a provider for a money advance
  • Utilize the new loan for repayment of the old ones
  • Repay the existing debts

Let us consider an example. You have a debt of $5000 in your balances spread over three separate cards. Each of them has an interest rate of more than 20%. With the help of debt consolidation, you can borrow the same funds at a percentage rate of, e.g., 15% and with a repayment period of 3 or more years. So you can save more money on interest.

Ways to Consolidate Debt

The most common practice is either to combine loans from all your cards into one or to take a separate loan from an independent lender or a specialized service. The most frequent questions borrowers might have are: does debt consolidation hurt your credit, and can it be beneficial for your credit rating? If the loan reduces your debt-to-income rate, it may help your credit score. If on the contrary, then you should choose another expert strategy.

  • Loans from specialized lending services allow you to use the received money to repay the debt. You can pay in installments during the agreed time. Many services do not focus on your credit history. Moreover, some lenders will even allow you to improve your credit score if you repay their loan on time.
  • To combine all credit debts on one card, you need to open a special account for consolidation. Get a 0% credit card and transfer the debt to your balance. In this case, your credit score plays a role. If you want to qualify for a transfer card, you need to have a high credit score, which starts from 690 points and above.

There are two more radical methods of consolidation. The first is to take out a 401k loan. You borrow money from your retirement savings account. The second way is a home equity loan. Both options involve high risks. In case of non-payment, you are threatened with deprivation of real estate or lack of funds for the period of retirement.

Is Debt Consolidation Worth It?

You may consider debt consolidation if you have several active loans with a high-interest rate. However, you should pay attention to your credit history. If you don’t have a good enough credit score, you’ll likely be turned down for the next loan with a lower interest rate. 

Consolidation is also worth it if you find that you cannot cope with existing problems and cost overruns. It is a smart move that might help you save money in the long term. 

Here are the main indicators that debt consolidation may be beneficial for you.

  • Your goal is to get out of the debt hole

Debt consolidation will help you make the necessary monthly payments faster and forget about them once and for all. This is a good solution to combine all installments into one with a low-interest rate. By consolidating, you build an effective strategy that will help you on your way to financial freedom.

  • Several monthly payments on your debts

The very essence of consolidation is unification. The main trigger for you is several large accounts that need to be managed monthly. Consolidation will help you structure your payments and become more financially organized. That way, you don’t split payments, risking forgetting about one, and instead, make one monthly installment.

  • Hefty interest rates

It is difficult to get rid of debt collections if you are charged high-interest rates. The situation becomes more complicated if you have to make several installments. In such a situation, you accumulate more and more interest every month. 

By consolidating debt, you will receive a lower monthly percentage rate. This will pay off in the long run when you see thousands of dollars in savings. A minor adjustment combined with one monthly payment can help you have a greater grasp of your budget.

  • You have a high credit score

Before you consolidate debt with a new loan, check your credit rate. Interest on the new loan depends on your credit history and score. Some borrowers do not pay attention to their credit history but instead help to build a new one. However, on average, your chances of getting a lower interest rate are more likely if you have a high credit rating. 

What to Consider Before Making a Move?

If you do decide to go down the path of consolidation, you need to have a plan and know where to start. If you don’t build an effective strategy, you may find yourself in even greater debt than before. Analyze why exactly you found yourself in such a situation. 

Maybe you have to cut unnecessary expenses or find an additional source of income. If you earn significantly less than you need for vital needs, then a consolidation loan will not be able to help you in any way.

Alternatively, you can always consult an expert credit consultant or hire a financial advisor. Credit companies will gladly tell you how to avoid further debts and how to spend money wisely. If you feel that you can do it on your own, plan your budget carefully. For instance, you can make a table where you need to specify the basic expenses. List the potential consolidation loan and calculate the balance of expenses and income.

Contact your borrowers. Some services offer negotiated conditions open for discussion. For example, you may be able to lower the interest rate or change the final payment date. In this case, you may avoid consolidation or postpone its receipt for later.

Debt Consolidation: Pros

Debt consolidation is frequently the most effective strategy for managing your finances. Here are some of its essential advantages.

  • A chance to improve your credit rating

If you consolidate debt, you can improve your credit score. If you transfer loans to credit cards and pay off debts, you reduce the level of credit utilization. This mark can reach 30% thanks to consolidation. As you make the required monthly payments on time and pay off the debt, you collect credit points and improve your rating. 

  • Faster Repayment Process

If you take out a new consolidation loan at a lower interest rate, you will be able to save more money each month. As a result, you will pay off the debt faster. You should remember that the consolidation of your debt can extend the repayment period. Therefore, you should set yourself the goal of paying off faster so as not to stretch the debt over time.

  • Effective budget management

You combine several payments into one and thus structure your debt expenses. You will be less likely to miss or delay an installment because it will be only one. In addition, debt consolidation is effective when planning the budget because the column of obligatory expenses will contain only one monthly payment.

  • Reduce the amount you pay each month

Everything is obvious because all your payments will be combined into one with an extended term. By consolidating your debt, you will pay less and save your monthly budget at the present moment.

  • The interest rate will be lower

By consolidating debts, you lower your monthly interest payment. This rule applies even if you have low-interest cash advances. Apply for a money service where you can pick up a custom loan in advance on your own. Note that some types of cash advances have slightly higher rates. For example, student loans for educational purposes have lower interest rates than transfer credit cards.

Debt Consolidation: Cons 

Despite a whole bunch of advantages, the consolidation strategy has some negative aspects that should not be neglected.

  • Push for additional expenses

Borrowers start thinking they have a larger budget than they have. As a result, debt increases, and balances do not fall but grow.

  • Increase in interest rate

Paradoxically, debt consolidation can play a cruel trick on you if you have a poor credit rating. Lenders issue loans to such borrowers at higher interest rates than your current ones.

  • Consequences if you miss a payment

The installments you make on consolidation affect your credit score dramatically. Additionally, delays entail high fees. Make sure that you have planned your budget in detail and that this payment will not be burdensome for you

  • Additional costs

If you do not read the terms of the new loan, you can get into trouble. For example, some services charge additional commissions for registration, transfers, and closing.

Public Debt Trend in the United States

Oddly enough, there is an unpaid debt even at the federal level. The large sums were initially needed at the time of the American Revolutionary War. The country borrowed more than $75 million from the French government and local solvent lenders. The government can now pay services and social payments to citizens, including through public debt.

As of 2023, the US government debt is $31.5 trillion. According to statistics, this figure first exceeded 31 trillion last fall. Over the next months, it increased officially by half a trillion. As we can see from the graph, the most rapid height of the debt figure from ca. 23 trillion to 27 trillion was recorded in 2020. 

The curve climbed upwards almost vertically. This is explained by additional infusions into the economy due to the pandemic crisis. The next sharp fluctuation is observed in the fall-winter season of 2021/2022 due to Trump tax cuts.

Bottom Line

To summarize, debt consolidation may be a useful technique for your debt management and financial stress reduction. It is also a good tool for attaining financial stability and peace of mind with proper planning and implementation. Given certain circumstances, such as many loans and high-interest rates, this may be one of the few correct decisions. 

But, before choosing if it is the right move for you, you should carefully analyze your budget, expenses, and ambitions. Consider the possible advantages and disadvantages of consolidation, and be careful to investigate and evaluate various consolidation alternatives and providers. This may be a temporary solution, but it will not bring the desired results if you do not control excessive spending.

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