Is Consolidating Debt A Good Idea? How to Tell

By: Kristina0 comments

When people deal with several high-interest debts or loans, they would usually consider debt consolidation as a solution to their problems. But is consolidating debt a good idea? The answer to that question depends on your financial situation. Let’s take a closer look at what debt consolidation really is and whether or not it is what you want. 

What Does Debt Consolidation Mean?

The consolidated debt definition refers to taking out a new loan to pay off smaller debts. You’ll combine several debts with payoff terms that are generally more favorable. These favorable terms feature a reduced monthly payment, interest rate, or perhaps even both. Consumers resort to this option to pay off several debts. That includes debt such as credit cards, student loans, and other types of liabilities. With this in mind, any payment from now on will be for the new debt.

Many consumers apply through their credit union, credit card company, or bank as the first step. It’s a beautiful place to start your debt consolidation journey, primarily if you’ve maintained an excellent relationship with your institution. And even if you’re not successful, you can try your luck with private mortgage companies or even lenders. 

In actuality, it’s virtually impossible to combine all loans. Every loan comes with its repayment terms and interest rate. Every loan is a contract where consumers borrow money and pay it back over a set of monthly payments. 

It’s worth noting that debt consolidation doesn’t wholly eradicate a consumer’s original debt. Instead, you’ll transfer your loans to a completely different kind of loan or lender. 

Types of Debt Consolidation

There are four major types of debt consolidation, including: 

  • Home Equity Loans

For those who have equity in their homes, applying home equity loans for debt consolidation could be a great solution for getting rid of credit card debt

Home equity loan interest rates would be far less than what consumers usually pay their credit card companies. In order to qualify for this, you need to have a fair amount of equity in your home. 

But even though interest rates are lower, the risk here is that now your property is on the line. If you’re unable to make your payments, then your home could be facing foreclosure. 

  • Debt Consolidation Loans

Most creditors, especially peer-to-peer levers and conventional banks provide consumers with debt consolidation loans as part of their payment plan to borrowers who have trouble managing the size of their outstanding debts. This is for consumers who wish to pay down several high-interest debts. 

  • Credit Card Balance Transfers

A 0% interest balance transfer card is by far the cheapest debt consolidation loan option available. These cards enable you to transfer the balance from every one of your credit cards and then have them paid off without any interest for an introductory period of 6-24 months. 

However, there are three major concerns that you need to take notice of when considering credit card balance transfers for debt consolidation, including:

  • Will you be able to qualify for this?
  • How much will you pay to get this?
  • Will the whole debt be paid off before the 0% offer is no longer valid?

Be advised that there could be a downside to this, which is a reduced credit score. If you put too much debt on a single credit card, it could negatively affect your credit score. Fortunately, the credit score rebounds when you pay the balance down. 

  • Personal Loans

You can also use personal loans for debt consolidation. These are unsecured loans that come with fixed payments over a given period of time. Once you’re qualified, you can use personal loans to consolidate debts. 

Although, you might experience trouble trying to get qualified for the loan depending on what your credit score is. If, for instance, you have a bad credit score, you might get approved for personal loans, but with a higher interest rate, otherwise, you’re not going to get approved at all. Taking loans of high interest would enable you to combine your balances, but in the long-run, you might not be able to save your money. 

How Debt Consolidation Interest Rates Are Set

There are two factors that mainly determine debt consolidation interest rates: a consumer’s credit score and the collateral that they offer for the loan. The credit score gives creditors an idea about the possibility of you being able to repay your entire debt within the given time period in accordance with the agreement that you signed with your lender. And if for some reason you were late on your payments despite paying them in full, then it will have a negative impact on your credit score. The more positive your credit score, the more likely the lender will be convinced that you’ll repay a brand new debt back without any issues. 

Collateral for a loan is an asset that a consumer pledges as loan security or guarantee in case they were unable to have their loans repaid. The only kind of collateral that credit unions and banks are interested in is the loan that can quickly and easily be turned into money. More often than not, this is either when a new vehicle is considered or even real estate. 

By having a large or highly positive credit score, there’s a chance you’ll be able to qualify for an unsecured loan (without requiring collateral) from a credit union or a bank and you might get a pretty good interest rate. But if the credit score is low, then you won’t be able to qualify for a low-interest loan – even if you had good collateral. 

Generally, the better you can offer collateral for a loan, the better your interest rate will be. By using your house as security, there’s a chance for you to qualify for the best interest rate around. Your chances will also be great if you offer your new vehicle as security, except the interest rate might not be as low compared to offering real estate. 

You can get low-interest rate loans from credit unions and banks. But if you apply anywhere else, the interest rate could very well be higher due to a higher risk of being involved with other lenders. Some companies may be able to consider old household appliances or vehicles as security for debt consolidation, but the interest rate can be high. 

Is Consolidating Debt A Good Idea?

Most ask the question “is debt consolidation a good idea?” and it pretty much depends on your financial situation. Now we’ll consider the hidden disadvantage of debt consolidation that most aren’t aware of before it’s too late. 

Unhealthy Financial Habits

In retrospect, consolidating several debts at a reduced interest rate may sound like a good idea. However, it comes with a huge risk in the form of losing your property. You may lose your car, retirement fund, life insurance, or anything else you might have used to secure your loan. Some assets like retirement funds or life insurance might not be available to you if you were unable to pay your loans back before you’re able to use them. 

The reason for the late payment is that sometimes consumers feel good about themselves for consolidating their debts. They’re happy that monthly payments come with a lower interest rate and that’s why they assume that they’re in the clear about spending more as a result. But the sad truth of the matter is that this confidence about spending more will do nothing but worsen their financial stance. 

In the long run, consumers might use up the limit of their new credit card or line of credit balance apart from their loan payments. This will have a massive impact on their credit to the point where they might not be able to qualify for a new loan for consolidated debts. 

That’s why you shouldn’t take this for granted. You’ll need to make a budget and ensure that you’re spending less than you’re earning every month. Once you start getting busier with your life, you’ll be thankful you established a budget to help you stay on track with your finances so you can avoid going back into debt, especially when your expenses go up.

Conclusion

At this point, there is no way that you don’t know the answer to the question regarding “is debt consolidation good or bad.” Whether or not you think debt consolidation is right depends on several factors. That includes your credit score, financial goals, and whether you can stay true to your budget. A budget is the only way to ensure that you are spending does not exceed your earnings.

FAQs

How does debt consolidation work?

Debt consolidation works by combining several smaller debts into one large debt. This allows you to make one single payment per month at a lower interest rate overall.

How long does debt consolidation stay on your record?

If the debt has been settled, then it will remain in the credit report for over 7 years.

When should you consider debt consolidation?

When you have several debts to account for, especially those of higher interest that you might miss out on.

How does debt consolidation affect your credit?

Debt consolidation can hurt your credit if you continue to make charges on your credit cards. It’ll also affect you if you’re 30 days or more late on paying for your debt consolidation loan.

Debt consolidation or debt – which is better?

To find out which of these is best for you, you need to consider your financial goals and credit score.

What is the average fee for debt consolidation?

Debt settlement companies charge somewhere between 15 to 25% for the number of services that they provide to consumers.

What is the disadvantage of debt consolidation?

The disadvantage of debt consolidation is that you could be paying more in the long run. What’s worse is that you could end up losing your house if you don’t make those payments on time.

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