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What Is Debt Consolidation, and Should I Consolidate?

What Is Debt Consolidation and Should I Consolidate

Debt consolidation combines several debts into a single payment, usually high-interest debt like credit card bills. If you can secure a reduced interest rate, debt consolidation may be a viable option for you. This will assist you in reducing your total debt and reorganizing it so that you can pay it off more quickly.

Debt consolidation is a sound technique you may tackle on your own if you’re dealing with a modest quantity of debt and just want to reorganize several bills with varied interest rates, payments, and due dates.

How to consolidate your debt

There are two main methods for debt consolidation, both of which combine your debt payments into a single monthly cost.

Get a balance-transfer credit card with no interest: Transfer all of your debts to this card and make a full payment during the promotional period. To qualify, you’ll most likely need good or exceptional credit (690 or better).

Take up a fixed-rate debt consolidation loan and use the funds to pay off your debts, then repay the loan in payments over a defined period of time. You can get a loan even if your credit is bad or fair (689 or below), but applicants with higher scores are more likely to get the best rates.

A home equity loan or a 401(k) loan are two other options for debt consolidation. These two possibilities, on the other hand, come with a risk – either to your property or to your retirement. In any event, the best alternative for you will be determined by your credit score, profile, and debt-to-income ratio.

When debt consolidation is a smart move

Consolidation strategy success necessitates the following:

  • Your total debt, excluding your home, is less than 40% of your gross income.
  • You have good credit and can get a 0% credit card or a low-interest debt consolidation loan.
  • Your cash flow covers your loan payments on a regular basis.
  • You’ve devised a strategy to avoid accumulating debt in the future.

Here’s an example of a situation where consolidation makes sense: Consider the following scenario: you have four credit cards with interest rates ranging from 18.99 percent to 24.99 percent.

Your credit is good because you consistently make your payments on time. You can be eligible for a 7 percent unsecured debt consolidation loan, which is a much lower interest rate.

Consolidation shows many individuals the light at the end of the tunnel. If you take out a three-year loan, you’ll know it’ll be paid off in three years if you pay on time and keep track of your spending.

Making minimum credit card payments, on the other hand, could take months or years to pay off, all while incurring more interest than the original balance.

When debt consolidation isn’t worth it

Consolidation isn’t a panacea for debt relief. It makes no mention of the spending patterns that lead to debt in the first place. It’s also not a good idea if you’re drowning in debt and can’t pay it off even with decreased payments.

If your debt burden is tiny — you can pay it off in six to a year at your current rate — and combining would save you only a small amount of money, don’t bother.

Instead, try a do-it-yourself debt repayment strategy like the debt snowball or debt avalanche.

If your debts equal more than half your income and the calculator above shows that debt consolidation isn’t the best option for you, you’re better off looking for debt relief.

Readers also ask

Is it a good idea to consolidate credit cards?

If you can secure a loan with better terms and/or it will help you make payments on time, consolidate your debt. Just be sure that this consolidation is part of a bigger debt-reduction strategy and that you don’t add additional balances to the combined cards.

How does a debt consolidation loan work?

You can utilize a personal loan to pay off your debts yourself, or you can hire a lender who will send money directly to your creditors.

Do debt consolidation loans hurt your credit?

If you make on-time payments and consolidate your credit card balances, debt consolidation can boost your credit. If you run up credit card bills again, close most or all of your remaining cards, or skip a payment on your debt consolidation loan, your credit may suffer.