Debt consolidation is a strategy many people use to manage debt. It often involves combining multiple smaller loans and getting a new loan to pay off existing dues. Debt consolidation can have many benefits for borrowers, such as a lower interest rate and an opportunity to improve one’s credit score. That said, one must consider a few factors before applying for this scheme, as it might not be suitable for everyone.
Benefits of debt consolidation
Every type of consumer debt can be consolidated, including student loan debt, credit card dues, and outstanding personal loans. Choosing to consolidate these by getting a new loan has several advantages.
Managing debts becomes easier
Consolidating debt by combining them into a single loan makes things much easier. It can lower the number of accounts one needs to track, saving time and effort. Even after using this strategy, the interest rate and total outstanding balance may sometimes remain the same, but managing the debt becomes simpler.
A lower interest rate may apply
People with good credit scores may qualify for debt consolidation with a better interest rate, which can dramatically lower the monthly payouts. Some may also be eligible for a balance transfer credit card. Those eligible can transfer multiple credit card dues and outstanding loans to this card. Doing so has many benefits, such as a low annual percentage rate for a limited period, like 12 or 21 months. Paying off the credit card debt within this period can help one save more.
The debt can be paid off faster
Reducing the interest on debt saves money and simultaneously lowers the time it takes to become debt-free. The sooner an individual can pay the debt, the sooner they can meet their other financial goals.
On-time payments can help build credit
If one qualifies for affordable payments under the consolidation scheme, they get a lower interest rate. Doing so can encourage one to make timely repayments and improve their credit score. Maintaining the credit score is important as it affects one’s chances of securing new lines of credit in the future.
Things to consider when opting for debt consolidation
Debt consolidation is not a quick fix because one still has to pay off the dues. So, one must consider a few factors before proceeding.
There may be upfront fees
Sometimes, a lower interest rate might not result in savings in the long run. Acquiring a new loan to pay past debt may instead involve an upfront origination fee in the range of 1-6 percent of the outstanding amount. Likewise, balance transfer credit cards may incur balance transfer fees of around 3-5 percent. Lenders may charge this fee upfront or add to the outstanding balance. One should always determine if they may save despite this fee before opting for consolidation.
Lenders may not offer favorable debt terms
One’s credit score determines the probability of getting a new credit card or a loan. It also determines the fee, interest rate, credit limit, and loan amount. People with poor credit scores may not get approved for debt consolidation or balance transfer credit cards. Even if approved, the terms may not be favorable. In this case, one may opt for consolidation via a debt management plan through a non-profit credit counselor.
It might result in higher debt
Consolidating debt can help one save money, provided they make timely repayments and meet the new terms and conditions. Failing to repay the new consolidated loan can put one in a worse situation than before.
Missing payments may harm the credit score
Not making timely payments, even after being approved for a new loan to pay off past debt, can considerably impact the credit score. If that happens, one may be unable to apply for other financing schemes from the lender.
Factors that influence one’s decision
Whether or not one should get a loan to pay off debt depends on multiple attributes.
Mindset
Those who are positive about their debt pay-off journey and are confident about using a consolidation plan to improve their credit standing may find this strategy helpful. On the other hand, if one thinks they may struggle with the new plan because of overspending, they must avoid opting for this scheme.
Credit offers
One needs to qualify for a new credit account before opting for consolidation. To check whether they qualify, one can assess their credit reports and credit score. These parameters may affect a lender’s decision about the new loan approval and the subsequent terms and conditions. One can decide whether to go ahead with the scheme depending on the consolidation offer they receive.
Motivation
Consolidation can be beneficial only if one sticks to the repayment plan in the long term. After agreeing to the consolidation scheme, one must avoid any more debt while paying off what is owed in time.
Since getting a new loan to pay off debt is a big decision, one should not rush the process. Researching and consulting experts can make things easier.