If you’re feeling overwhelmed by managing multiple high interest debt payments, you might want to consider debt consolidation. This option can help you simplify your finances and, in some cases, help you save on interest or lower your monthly payment.
However, debt consolidation isn’t always the right answer. Like other financial options, it comes with its own advantages and disadvantages. Understanding the pros and cons of debt consolidation will help you make the right decision for you.
What are the pros and cons of debt consolidation loans?
Debt consolidation can simplify debt management — but knowing both the positives and negatives can help you make an informed choice.
Pros of debt consolidation
Simplified payments. Managing multiple debts can be stressful. Debt consolidation combines multiple debts into a single regular payment. This can make it easier to stay on top of your repayment schedule.
Build your credit history. Making and keeping track of one repayment can make it easier to ensure you’re paying on time. Your repayment history accounts for 35% of your FICO score, so consistent on-time payments could help you build your credit history.
Bring your accounts current. Paying off overdue accounts with a debt consolidation loan or balance transfer credit card can save you a lot of stress. Not only can past due accounts affect your credit score, they can also cost you late fees and accumulating interest.
Save money on interest. If you move higher-interest debt to a debt consolidation loan with a lower interest rate, it can help save you money over time. However, this may require you to have a good credit score. Additionally, some balance transfer credit cards may offer a 0% promotional period for a certain period of time — which can also help you save money on interest.
Cons of debt consolidation
Long-term cost. Refinancing your debt can often extend your repayment period. This means you will likely be accumulating and paying interest for a longer amount of time. This can increase the overall amount you repay.
Fees. In addition to paying more interest, debt consolidation may also come with some upfront costs. These types of fees can include origination fees or balance transfer fees.
It can be difficult to qualify. If you have a low credit score, it may be difficult to qualify for a good debt consolidation option. If you do get approved, you might not get a significantly lower interest rate or better repayment terms than your current debts.
Accumulation of debt. When you consolidate your debt, it can be tempting to use the newly available credit again. This can lead you to accumulate even more debt than you had in the first place. This can lead to more financial strain and may lower your credit score.
What types of loans can be used to consolidate debt?
Installment loans
Installment loans are a type of personal loan that are commonly used for debt consolidation. They provide borrowers with an upfront lump sum of money that can be used to pay off current debts. You’ll then repay the lender in installments over time.
While installment loans can be useful, there are few things you may want to consider before applying for a new loan. Review the loan terms and check to see if the loan comes with a lower interest rate. If the loan you take out has a higher interest rate, it won’t help you save money.
Additionally, think about the term length. While a longer term can help reduce your payment amount, you might end up paying more interest over time.
You should only borrow what you need to cover your current debts. Taking out more than you need can create more strain and may stop you from achieving your financial goals.
Balance transfer credit cards
Balance transfer credit cards allow you to move credit card debt onto a single card. They often come with promotional offers such as 0% interest for a certain period of time, which can help you pay off debt faster. Keep in mind that these cards may be more difficult to qualify for.
There are several important factors you may want to consider. Look out for balance transfer fees, which are often a percentage of the amount being transferred. These fees can add up quickly and can reduce the amount you save. You’ll also want to understand the terms of the promotional offer and what your new interest rate might be after the introductory period ends. Any late or missed payments can also cancel out your promotional rate, and negatively affect your credit report or lower your score.
Line of credit
A line of credit can also be used for debt consolidation. A revolving line of credit gives you access to funds up to a set credit limit. These funds can be used to pay off existing debt and then paid back over time. As you repay the line of credit, the funds become available to borrow again.
Before applying, there are a few things you should consider. Some lines of credit may come with variable interest rates, which means you could be hit with a higher interest rate at some point. You should also look out for fees such as annual fees or maintenance fees, which can increase the overall cost of borrowing. You should also keep in mind that a line of credit can make it easy to overspend, which can increase the amount of debt and undermine your debt management plan.
Is debt consolidation a good idea?
Debt consolidation can be a good idea for individuals who have a lot of high-interest debt. It can help simplify your payments, potentially get you a lower rate and become debt-free faster. However, it’s not always the right solution for everyone. It can be difficult to qualify for these types of loans and you may not be able to save significantly on interest. In these cases, another debt management plan or financial counseling could be a better fit. Ultimately, it depends on your unique financial situation.
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