Debt consolidation is a viable method of achieving debt relief for many who have found themselves in debt with multiple creditors. This form of debt relief can roll numerous payments into one single payment while potentially saving money on interest fees.
Unlike several other types of debt relief, consolidation methods will not generally harm your credit further, so long as you make timely payments. But, it is essential to learn about debt consolidation companies as well as other methods of consolidation before you decide how to tackle your debt.
In doing so, you will learn more about how consolidation works and the options that are available to you. While consolidation can help you find financial freedom, this method of debt relief is not for everyone. Therefore, it is crucial that you learn when consolidation is best avoided.
1. What is debt consolidation?
Debt consolidation is a debt relief method that “consolidates” other forms of debt that you owe into one singular loan. This can make large amounts of debt (or multiple types of debt) more manageable, as you will only have one payment to make on your debt instead of several going forward. Additionally, you may be able to reduce the total amount that you will pay on your debt by lowering interest rates and other reoccurring fees.
2. How does debt consolidation work?
If you are considering debt consolidation as a way to achieve financial freedom, then it is essential that you understand how it works. In learning about consolidation, you will know what to expect should you choose to consolidate.
Consolidating your debts into a singular debt will require you to:
- Work with one of the debt consolidation companies.
- Obtain a consolidation loan.
- Utilize a balance transfer credit card or another popular method.
Once you have the means of consolidation, you can repay all of your applicable debts. The money that you previously owed to multiple creditors will now be repaid to one lender. Under the right circumstances, you may be able to repay your debt faster through consolidation while saving money on interest.
Your new payments will include an interest rate that is specific to your consolidated loan, regardless of the interest rates that were previously associated with your various debts. Rather than paying multiple creditors, you will make payments to just one.
However, debt consolidation loans and companies are not the best options for everyone. If you face higher interest rates than what you previously had, then you will likely pay more over the life of the loan.
Additionally, certain loans and balance transfer credit cards include lower interest introductory periods followed by periods of high interest. If you are unable to repay the full amount of your debt before the end of the opening period, then you may ultimately pay more.
3. Common Debt Consolidation Options
By learning more about debt consolidation loan and company options, you will gain the ability to make an informed decision on your financial future. While there are several consolidation options available, the most common include:
- Personal loans.
- Balance transfer credit cards.
- Utilizing companies that specialize in consolidation.
Personal Loan for Debt Consolidation
You can obtain a personal loan for debt consolidation that can assist you in repaying your other forms of debt. Once your balances are transferred to the new loan, you must make payments on the loan over a set term length.
However, the best loans will require you to meet specific eligibility requirements, including credit score and debt-to-income ratio standards. This can be tricky depending on how well you have managed your debts up until this point. If a lender offers you a loan that contains an interest rate that is higher than many of your debts, then it could cost you more to repay your debts.
Debt consolidation loans can be secured or unsecured loans. While certain secured loans, such as a home equity loan, can reduce your interest rates, these loans carry risk.
Generally, you must put up some form of collateral, such as your home or vehicle. If you are unable to repay, the lender can seize or foreclose upon your property.
Balance Transfer Credit Cards
Another popular method of debt consolidation is the use of balance transfer credit cards. These cards offer an introductory period that includes a very low-interest rate, typically zero percent. This promotional period may be between six and 24 months, depending on the card.
Balance transfer credit cards can be an excellent method of repaying your debts in full, but only if you will be able to repay all of your debt before the promotional period ends. This is because these cards have notoriously high-interest rates after the promotional period, leaving borrowers paying more than they would have before consolidation.
Balance-Transfer Cards to Consider
- American Express Cash Magnet Card
- BankAmericard Credit Card
- Citi Simplicity Card
- Discover it Balance Transfer
- Wells Fargo Platinum Card
Utilizing Debt Consolidation Companies
Debt consolidation companies are an attractive option for some borrowers, as the company typically handles paying creditors for you on your behalf. Rather than paying each of your creditors directly, you would pay the consolidation company that would then submit payments to your creditors for you.
These companies are the “middle man” of consolidation. They are not necessary but can be beneficial for some borrowers due to their simplicity and convenience. Two debt consolidation loan providers include Marcus by Goldman Sachs and OneMain Financial.
However, it is essential to take note of any fees that a company may charge, as most companies take a percentage of your debt or base their fees off the number of creditors that you have.
4. When Debt Consolidation is Recommended
Obtaining a debt consolidation loan or seeking assistance from a consolidation company can help you achieve financial freedom. Consider consolidating your debts if:
- The total amount that you owe, excluding your mortgage, does not exceed 40 percent of your gross annual income.
- Your credit score is high enough to qualify for a 0 percent or low-interest rate.
- You can consistently cover payments towards the amount you owe.
- You have a plan in place to prevent yourself from falling into debt again in the future.
5. Knowing When to Avoid Debt Consolidation
Debt consolidation is not the best option for everyone. Experts recommend that you avoid consolidation options if you:
- Are overwhelmed with debt, and you have no means to repay your debt, even with reduced payments.
- Have an overall amount of debt that is relatively small and you could pay it off within 6 to 12 months with your current repayment method.
- Have an overall amount of debt that is more than half of your income.