What Is Debt Consolidation And Is It A Good Idea?
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According to Experian 2021 credit report, American consumers with credit card debt have an average balance of $ 5,525, while the average credit card interest rate is currently well over 16%.
For people defaulting on payments, a heavy debt burden and high annual interest rate (APR) can be combined in the worst possible way, often creating a cycle of high-interest debt that consumers cannot escape. And even for those who do can Keeping up with monthly payments, excessive credit card debt can prevent you from achieving other financial goals, such as saving for the future.
Either way, debt consolidation offers a way out of credit card debt that is far less severe than bankruptcy. You just have to be willing to come up with a plan and stick to it until you are out of debt. If you are interested in getting rid of debt for good, read on to learn how debt consolidation can help.
If you’ve tried planning your way out of debt or making more money but nothing seems to work, debt consolidation could be the answer you are looking for. With debt consolidation, you are essentially trading in the loans and credit card balances you have for a new loan product with better rates and terms, either lowering your monthly payments or making it easier to get more of your money for capital reduction Debt or both.
Essentially, on a debt consolidation, you take out a new loan and use the proceeds of that new loan to pay off all of your old debts and then make monthly payments on just the new loan. In general, there are three financial products that consumers use for debt consolidation:
- Debt Consolidation LoansLoans, also known as personal loans, allow you to refinance your debts into a new, fixed-rate, fixed-term loan.
- Credit cards with credit transfer you can consolidate debt on a new credit card that offers 0% APR for a limited time.
- Home loan can help you consolidate debt into a new loan product that is backed by the value of your home.
Whichever product you choose, keep in mind that debt consolidation will only work if you can stop accumulating more debt. If you are consolidating debt with a personal loan or credit card for the balance and continue to place more purchases on other lines of credit, debt consolidation is likely a waste of time.
Debt consolidation may or may not be a good idea. It all depends on how serious you are about the process and whether you have the discipline to go through with it.
As an example, let’s say you currently have $ 5,525 in credit card debt at 19% APR. In this scenario, you could be paying $ 100 per month on this debt for 133 months – or more than 11 years – before it was paid off. During that time, you would be giving up over $ 7,701 in interest.
But what if you bundled that $ 5,525 debt into a single personal loan? While personal loans vary, most will allow you to borrow between 2 and 7 years. Personal loans also come with fixed rates, fixed repayment periods, and fixed monthly payments.
In this example, it is possible that you could qualify for a 60 month personal loan with an interest rate of 7%. In this case, you would pay off your balance with a monthly payment of $ 109 for five years (60 months). Over that period, you would be paying approximately $ 1,039 in interest payments. That’s a huge savings of over $ 6,000.
You can also consolidate debt with a credit card. It is important to note, however, that while transferring credit cards offer an introductory 0% APR on transferred balances, the longest possible term is currently 21 months. After that, your interest rate will return to the regular APR, which is always on the high side.
For this reason, a credit card transfer only makes sense if you have an amount of debt that you can pay off during the introductory phase of the card. If you are taking more time getting to grips with your debt than a balance transfer can allow, you should consider a personal loan instead.
Finally, you can also consolidate debt with a home equity loan that uses your home as collateral. In many cases, this can be a good idea as home equity loans can come with a low fixed rate, as well as a fixed monthly payment and a fixed repayment period. Remember that to get a home loan you need good credit and if you default on payments you can lose your home.
However, in any of these cases, if after you consolidate your debt, you overspend and incur another $ 5,000 in debt on the same original credit card that you previously used, and you can afford to make $ 100 monthly payments for To pay this debt, you end up paying an additional $ 4,985 in interest. Add that interest to the additional $ 5,000 in debt and you will be worse off than you started. This is why it is so important to stay disciplined and stop spending while pursuing a debt consolidation program.
There are other debt consolidation options that you can consider, some of which offer third-party help. For example, you might consider signing up for a debt management plan (DMP), which takes place when a credit repair agency helps you negotiate interest rates and pay off your debts over a set period of time.
Just note that DMPs are not for everyone and that the credit repair agencies that offer DMPs can’t do anything that you can’t do for yourself. Also, a number of credit repair agencies have earned themselves a bad rap, so make sure you do plenty of research before going down this route.
Another alternative is debt settlement, a process that helps you settle your debts for less than you owe. However, it is important to know that debt settlement companies are asking you to stop paying your debt while they are working on your behalf. Unsurprisingly, this can do significant damage to your creditworthiness that can last for years.
Debt management becomes a lot easier when you have a decent interest rate and a monthly payment that matches your income. In most cases, this is the job of debt consolidation – it helps you convert high-interest debt into a new financial product on better terms.
Debt consolidation also has the benefit of allowing you to reduce the monthly payments you make. If you’re currently trying to keep up with five or six credit card statements, consolidating debt with a personal loan company or peer-to-peer lender can help you move to a monthly payment.
With this in mind, there are several factors that can determine whether a debt consolidation is an option for you. These include:
- Your credit rating: You need a good credit score or better to qualify for a personal loan with the best interest rates and terms. If your credit score is poor, you may not qualify for a new loan with better interest rates than you do now.
- Your Desire to pay off debts: Debt management takes time and effort, and it can take years to pay off debt in full. If you are not serious about debt consolidation, you may not be better off with a debt consolidation loan.
- Your ability to avoid new debt: In order for your debt consolidation to be a success you must stop getting into more debt. While you are paying off your debt consolidation loan, you should only use cash or direct debit. At the very least, you should be economical with credit.
So should you consolidate your debt? If you’re paying off high APR credit cards, debt consolidation may be just what you need. Remember that the only way to pay off debts is if you work out a plan and, most importantly, stick to it. If you take out a personal loan and keep falling into debt with credit cards, you could be in worse off in the long run.
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