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Debt can feel like a weight on your shoulders. Add to that the hassle of juggling different bills, interest rates and due dates, and debt can feel downright crippling. How can you make your debt more manageable?
Debt consolidation can help simplify your finances. It combines your existing debt balances into one loan with a single monthly payment and typically a lower interest rate. Debt consolidation loans are a type of personal loan used to consolidate debt, but there are other types of loans and credit cards that you can use instead.
Before you consolidate your debt, it’s important to understand exactly what you’re signing up for. Here are seven facts you should know about debt consolidation.
1. Debt consolidation won’t eliminate your debt
Debt consolidation can help with many things. It converts multiple bills into one monthly payment, and it may also trim your overall interest rate. However, debt consolidation won’t magically get rid of your debt. This can be problematic if you don’t change your spending habits.
“People think debt consolidation will solve all their problems. But if you don’t address how you’re overspending, debt consolidation is not the answer you’re looking for,” said Todd Christensen, an accredited financial counselor and education manager at Money Fit, which offers nonprofit credit counseling. “It’s best for someone who’s disciplined and has identified and eliminated the causes of their debt.”
Before you consolidate, make sure you have a strategy in place to make your payments and avoid racking up more debt.
2. You can consolidate different types of debt
Debt consolidation loans can be used for a variety of unsecured debts, including credit card balances, other personal loans, medical bills, outstanding utility bills and taxes. Keep in mind, however, that you may lose certain protections and benefits if you consolidate one kind of loan — especially student loans — with another.
“With federal student loans, for example, the lender has to offer certain repayment and deferment options if you lose your job,” said Christensen. “If you pay that off with a debt consolidation loan, the new lender does not have to offer you those benefits.”
3. You may need to provide collateral to consolidate your debt
There are two kinds of loans you can use to consolidate debt: unsecured and secured. While unsecured debt consolidation loans and balance transfer credit cards don’t require collateral, they may come with a higher interest rate and stricter qualification requirements.
Using a secured loan — such as a What is a Home Equity Loan? — to consolidate other debts may help you lock in a lower interest rate. But be mindful about making prompt payments on secured loans — your valuable property is on the line.
4. There are several ways to consolidate debt
As mentioned above, there are a number of different personal loans that can be used for debt consolidation. In addition to those called debt consolidation loans, you can use a home equity loan or home equity line of credit. There are pros and cons to each type of loan, so explore options from a variety of lenders to see which best suits your needs.
Balance transfer credit cards that offer 0% interest for a set period of time can also be a smart debt consolidation strategy for borrowers who feel confident they can pay off the entire balance before the promotional period ends.
5. You may need to pay fees to consolidate debt
Many debt consolidation strategies come with fees that can increase your total payment. Home equity loans can include fees for home appraisals, while personal loans may come with origination fees.
Balance transfer credit cards have fees, too. “You may pay a 3-5% fee on credit card balance transfers, but if you can get that debt paid off before the 0% interest period is up, then that will probably be less interest then you would pay back otherwise,” said Christensen.
Weigh the upfront fees against your financial goals to see if debt consolidation will benefit you in the long run.
6. Debt consolidation can extend the life of your debt
When you choose debt consolidation, you’re taking out a new loan that may have different terms than your existing debts, ultimately extending the life of the loan. If the longer term trims your monthly payment and makes your debt manageable, it might be worth the trade-off of carrying a balance for a longer period of time. But be sure you weigh the overall interest costs before you finalize your decision.
7. Your credit score may impact how you consolidate debt
Whenever you’re taking out a loan, you can expect lenders to take a close look at your credit report and credit score. Your score can affect the debt consolidation options available to you. The higher your score, the more likely it is that you’ll qualify for a lower interest rate on a debt consolidation loan.
Borrowers with fair or bad credit scores can still qualify for debt consolidation, but may need to secure the loan with collateral or pay a higher interest rate than their original loans.
If you’re having trouble keeping up with your debts, debt consolidation might be the solution to reduce your monthly payments and potentially cut your interest rates. However, this financial strategy can backfire if you end up paying lots of fees and digging yourself into a deeper hole. Carefully consider the terms of any debt consolidation plan to make sure the long-term benefits outweigh the costs.