Are you in the — incredibly large — group of people that owe $$ to at least one person/entity? If yes, then you are not alone. According to the Federal Reserve, consumer debt (as of February 2018 for both credit card and fixed payment loans) is currently at $3.867 trillion. Because of this, some consumers with several debts under their name consider debt consolidation to help them manage their financial obligation. If you’ve been considering debt consolidation, or simply have debt and questions (don’t we all) then this article is for you.
Debt Consolidation, Defined
This is a type of unsecured personal loan that combines and replaces existing debts such as credit card debts and personal loans.
It aims to:
- Simplify payments
- Avoid higher interest rates to help you save in the long run
- Reduce monthly payments
In other words, debt consolidation means you have one loan with one interest rate, monthly payment, and due date.
The Benefits of Consolidating Debts
There are three main advantages:
- Lower Interest Rate – You don’t have to worry about multiple rates anymore because when you consolidate your debt, only one rate will prevail. This will help you save more in terms of interest payments.
- Change in Monthly Payment – Aside from lower interest rate, paying your loan every month is easier since you only have to keep track of a single debt.
- Adjusted Due Date – Have you experienced not knowing which of your loans are already due? You get to skip that when you consolidate since there will only be one maturity date.
The Drawback of Debt Consolidation
Despite the benefits, consolidating your debts into a single loan has drawbacks too.
An example would be the agreed term and due date of the consolidated loan. The longer the loan term, the smaller the monthly payment will be. While this sounds appealing, you might end up paying your loan longer compared to leaving your loans as is. A longer repayment period also means you’re paying more interest, which may not be beneficial in the long run.
On the other hand, a shorter loan term equals a higher payment every month, which could be heavy on the pocket. The good thing about this is that you will finish your loan faster and pay less interest overall.
No, Debt Consolidation Does Not Reduce Your Debt
Sadly, your debt will not decrease if you consolidate.
It’s natural for you to feel “liberated” since a huge responsibility was taken off your shoulders. Still, this doesn’t change the fact that you still have a financial obligation waiting to be paid – and you still need to do something about it. The difference is that this time, you only have to worry about a single loan.
Credit History Matters a Lot
It is easy to consolidate debts. The question is, are you qualified to consolidate?
Keep in mind that lenders pay attention to your credit history and frequency of payments. If they see that you regularly pay off your loans, regardless of the amount, they would more likely extend a helping hand to make repayment easier. You would be able to negotiate terms in your favor since lenders see that you are a responsible and diligent borrower.
Pitfalls to Be Avoided
There are several, actually. This includes:
- Debt Consolidation Services – Sadly, many people are taking advantage of this industry, thereby ruining the reputation of those who are doing business legitimately. Make sure you dig deeper and find everything you need to know about your chosen debt consolidation company to avoid getting scammed – and paying more in the long run.
- Origination Fee – Aside from interest rate, there are debt consolidation companies who charge an origination fee, which ranges between one and six percent. This is usually deducted from the consolidated loan. The good news is there are lenders who don’t charge the origination fee, so make sure you go for them.
- Borrowing After Consolidation – Consolidating your debt doesn’t mean you erased your loans. Your financial obligation remains. That is why at this point, avoid applying and eventually accumulating new loans. This won’t help your financial standing. “What if I’m looking for ways on how to refinance student loans?” you might ask. Make sure you go for a debt consolidation company that will give you the most flexible and convenient payment scheme so you don’t swim in a pool of debt.
Alternatives to Debt Consolidation
Is debt consolidation the best strategy for you? It could be, but negotiation of terms and knowing how much you have to pay monthly as opposed to non-consolidated debts could be the deciding factors. Take note of the pitfalls and drawbacks to make this work for you.
- Plan your repayment method. It is recommended that you pay the debt with the highest interest rate since you can save more on interest, but you can also prioritize loans with the smallest outstanding balance or early due date if you need the motivation of seeing balances disappear.
- Change bad money habits such as spending too much on coffee every morning or eating out regularly.
- Look for extra ways to earn money to pay for your debts. You can always try freelancing or turning your hobby or passion into cash.
- Use extra cash such as bonuses you got from your job to pay off your financial obligation.