Pros And Cons Of Debt Consolidation: Keeping track of payments and balances on existing bills can be challenging with credit cards, student loans, and auto loans. Although combining several loans into one may simplify your finances, it is unlikely that the fundamental problems will be resolved. For this reason, before agreeing to a new loan, it’s crucial to comprehend the benefits and drawbacks of debt consolidation.
We’ll go over the benefits and drawbacks of this well-liked tactic so you can decide if debt consolidation is the best approach to pay off your debts.
What is Debt Consolidation?
A debt consolidation loan or balance transfer credit card is used to pay off several obligations, frequently at a cheaper interest rate.
Using a personal loan to pay off multiple loans at once is the practice of debt consolidation. Even while some lenders provide specialized debt consolidation loans, you can use the majority of regular personal loans for this purpose. Similarly, although some lenders transfer loan funds so the borrower can make payments on their own, others pay off loans on the borrower’s behalf.
For a period of between six months and two years, qualifying borrowers can often take advantage of a 0 percent introductory APR with a balance transfer credit card. When opening the card, the borrower can specify the balances they wish to transfer, or transfer the balances after the provider issues the card.
Is Debt Consolidation a Good Idea?
If a borrower has a number of high-interest loans, consolidating their debt is typically a wise choice. It might only be practical, nevertheless, if your credit standing has increased after you applied for the initial loans. Consolidating your obligations might not be beneficial if your credit score isn’t high enough to get a better interest rate.
If you haven’t dealt with the underlying issues, such as excessive spending, that contributed to your current indebtedness, you might want to reconsider debt consolidation as well. It is not acceptable to use a debt consolidation loan to pay off several credit cards in full because doing so could result in further financial difficulties.
Pros of Debt Consolidation
Debt consolidation has a number of benefits, including quicker, easier repayment and lower interest costs.
1. Streamlines Finances
You have fewer payments and interest rates to be concerned about when you combine several outstanding debts into a single loan. By decreasing your likelihood of making a late payment or missing a payment entirely, consolidation can also help your credit. Additionally, you’ll know more precisely when all of your debt will be repaid if you’re striving for a debt-free way of life.
2. May Expedite Payoff
Consider making additional payments with the money you save each month if the interest on your debt consolidation loan is lower than it would be on the individual loans. This can assist you in paying off the debt sooner and reducing your overall interest costs. To take advantage of this benefit, you’ll need to make a point of paying off your debt early because debt consolidation frequently results in longer loan terms.
3. Could Lower Interest Rate
Even if you have largely low-interest loans, you might be able to lower your overall interest rate by combining debts if your credit score has increased since you applied for other loans. If you don’t consolidate with a long loan term, doing so can help you save money throughout the course of the loan. Shop around and concentrate on lenders that provide a personal loan prequalification process to ensure that you receive the most affordable rate available.
But keep in mind that some debt carries greater interest rates than others. For instance, the rates on credit cards are typically higher than those on student loans. It is possible to get a personal loan to pay off several obligations at a rate that is lower than some of them but greater than others. In this case, focus on what you’re saving as a whole.
4. May Reduce Monthly Payment
Your total monthly payment will probably reduce if you consolidate your debt because future payments will likely be stretched out over a longer loan term. Even though this may be favorable in terms of monthly budgeting, it implies that you can end up paying more for the loan overall, even if the interest rate is lower.
5. Can Improve Credit Score
Your credit score can temporarily decline as a result of applying for a new loan due to the hard credit investigation. But debt consolidation also has a variety of other benefits that can raise your rating. Paying off revolving credit, such as credit cards, for instance, can lower the credit usage rate that’s displayed on your credit report. Your usage rate should ideally be around 30%, which you can achieve by appropriately consolidating your debt. You can also raise your score over time by consistently making on-time payments and, eventually, repaying the debt.
Cons of Debt Consolidation
It could seem like a good idea to streamline debt repayment by using a debt consolidation loan or balance transfer credit card. Despite this, there are certain dangers and drawbacks to this tactic.
1. May Come With Added Costs
The cost of obtaining a debt consolidation loan may also include origination, balance transfer, closing, and annual fees. Before signing on the signed line with a lender, be sure you comprehend the actual cost of any debt consolidation loan.
2. Could Raise Your Interest Rate
Consolidating your debts may be a wise choice if you are eligible for a lower interest rate. You can be forced to accept a rate that is higher than on your existing loans if your credit score isn’t high enough to obtain the most competitive rates. This can entail paying origination fees in addition to interest over the life of the loan.
3. You May Pay More In Interest Over Time
Consolidating your debt may lower your interest rate, but you may end up paying more in interest over the course of the new loan. When you consolidate debt, the payback period begins immediately and could last up to seven years. Although the total amount of your monthly payments could be less than you’re used to, interest will accumulate over a longer period of time.
Budget for monthly payments that are more than the minimum loan amount to avoid this problem. In this method, you can profit from a debt consolidation loan without paying the higher interest rate.
4. You Risk Missing Payments
Missing payments on a debt consolidation loan—or any loan—can seriously harm your credit score and incur additional costs. Examine your spending plan to make sure you can comfortably afford the new payment to prevent this. Use autopay or any other technologies that can help you prevent missing payments after consolidating your debts. Additionally, inform your lender as soon as you suspect you’ll be unable to make a payment on time.
5. Doesn’t Solve Underlying Financial Issues
Debt consolidation can make payments easier, but it won’t change any ingrained financial practices that contributed to the debts in the first place. In reality, many debtors who employ debt consolidation wind up with higher debt levels since they didn’t control their expenditures and kept accruing debt. Therefore, if you’re thinking about debt consolidation to pay off several credit cards that are at their maximum limit, start by establishing sound money management practices.