What is Debt Consolidation and How It Can Save You Money

Debt consolidation can merge all the monthly payments to consolidate them into a single monthly payment plan. It is perfect for such times when one cannot raise high interest on credit cards, personal loans, payday loans and medical bills because it makes the payment way more affordable and easier for management.

What is Debt Consolidation

Debt Consolidation puts together all your different debts and combines them into a loan with a better interest rate. You make one payment instead of many different bills each month. That way, it works really well with any debt, such as credit cards, personal loans, medical bills or even student loans, making your monthly payments cheaper and helping you to be better prepared in your pursuit of becoming debt-free. You will not have a lot of different due dates or varying interest rates.

Benefits of Debt Consolidation: Simplify Your Life

Combining your debts into one loan will save you money and give you control of your finances.

Here are 5 ways debt consolidation will help you:

1. Lower Interest Rates = More Money

You’ll pay less in interest. The Federal Trade Commission says consolidating high interest debt will save you money over time.

2. One Payment to Track

Instead of juggling multiple bills with different due dates you’ll have just one monthly payment to worry about. Easier to manage.

3. Better Credit Score

When you pay off your consolidated debt on time your credit score will improve. The Consumer Financial Protection Bureau says this shows lenders you’re reliable and that helps your credit score.

4. Easier Budgeting

A fixed monthly payment makes budgeting a breeze. You’ll know exactly how much to set aside each month so you can manage your money better.

5. Faster to Being Debt Free

With lower interest rates more of your payment goes towards paying off the actual debt not interest charges. That means you’ll be debt free faster.

Learn More: What happens to your credit score when you pay off all the debt.

How to Consolidate Debt

There are different ways of consolidating debt. There are advantages and disadvantages attached to each option, which makes it better to choose what suits you best according to your situation.

Balance Transfer Credit Cards

You can consolidate your debt through a balance transfer credit card. This will enable you to transfer all the balance from your current credit card to a new card with less or no interest for an introductory period. It has a promotional period averaging 12 to 18 months in most cards, where you can service your debt without added charges of interest.

Be aware that this may incur a transferring fee between 3% and 5%. Plus, if you do not settle upon maturity, you'll find yourself with a higher rate of interest.

Debt Consolidation Loans

A consolidation loan is a further strategy toward debt control. In the consolidation, you secure an individual personal loan by combining all debts but this time at cheaper rates. Through its mode, you have equal regularized monthly repayment for usually five to seven years on predictable terms without variations due to fixed rates or fees, such as 1% to 5%. Besides getting better returns, such benefits apply under good credit as an add-on factor.

Use our free calculator to determine your loan's Annual Percentage Rate

Home Equity Loans or HELOCs

If you own a house, you can borrow money based on the value of your house through a home equity loan or a Home Equity Line of Credit (HELOC). These normally carry relatively low interest rates. Be very careful, though - if you cannot pay back, you may lose your house. You will also be liable for extra fees, including closing fees and charges to appraise your home.

When Consider Debt Consolidation is a good option

Debt consolidation can work only in select cases. Having this knowledge will help you decide whether or not it fits your financial needs.

When It Makes Sense:

• Your debt payments should be manageable and should not exceed 50% of your pre-tax income.
• You should be qualified for interest rates that are less than what you're already servicing on your debts.
• You should get a steady income that prevents you from missing one single monthly payment.
• You want to simplify your finances by having one payment to track instead of many.

Things to Watch Out For:

• Do not overspend. If you continue to use the same credit cards every month following your debt consolidation, then you might end up with more debt than before.
• There is a high chance you might not qualify for good rates if your credit score isn’t high enough.
• Beware of fee-based charges like transfer fees or loan charges on the consolidation loan.
• If you use your home to secure the loan, remember that you could lose your house if you cannot pay.

Common Mistakes to Avoid

Once you have made the decision to consolidate debt, you need to know the common mistakes people usually make to avoid those problems, such as:

Not Making a Budget

One of the biggest mistakes is not having a budget you have created for yourself after consolidating your debts. You do not track where and how much you spend, and this may put you right back onto credit cards. Create a clear budget and adhere to it.

Not Reading the Fine Print

Often, people don't bother reading the terms associated with their consolidation loan or balance transfer card. This can often catch them off-guard with surprise fees or a higher interest rate down the line. If you don't understand, ask questions.

Skipping Professional Help

Credit counseling services are available for your help. Many people are so confident that they will solve everything alone, not realizing that experts can advise you with great tools to manage money even better. Their guidelines could make a big difference in keeping you on track.

Not Ready for Long-Term Commitment

Debt consolidation is not a magic and quick fix; it requires a commitment of your time in months or years. You have to be ready to make regular repayments for months or even years. Thus, if you are unprepared for such a commitment, you might miss some payments, hence damaging your finances more.

Forget About Emergency Savings

While paying off debt is important don’t forget to save some money for emergencies. Without emergency savings any unexpected expense could force you to use credit cards again and get back into debt.

Alternative Ways to Handle Your Debt

If debt consolidation isn't right for you, don't worry. There are several other ways to handle your debt that might work better for your situation.

Debt Management Plans

A Debt Management Plan could be your first option. This plan involves working with a non-profit credit counseling agency that creates a payment plan fitting your budget. The agency works with your creditors to lower your interest rates, remove fees or reduce your monthly payments.

You'll make just one payment each month to the agency and they'll handle paying your creditors. While this plan usually takes 3-5 years to finish, you might need to close your credit cards and it won't damage your credit score as much as other options.

Debt Settlement

Debt Settlement offers another path forward. With this approach, you work to get your creditors to accept less than what you owe. Companies offering this service will ask you to stop paying your bills and instead save that money in a separate account.

Once you have saved enough, they will try to negotiate with your creditors to reduce your debt, sometimes by 50% or more. Keep in mind that this will hurt your credit score and you might need to pay taxes on any forgiven debt. Also not every creditor will agree to settle.

Bankruptcy

Bankruptcy is a legal option that helps people who can't pay their debts start fresh. Chapter 7 bankruptcy can clear most unsecured debts within 4-6 months, while Chapter 13 sets up a 3-5 year payment plan. However, bankruptcy comes with serious effects.

It stays on your credit report for 7-10 years, making getting loans or credit cards difficult. It can also affect your ability to rent apartments or get certain jobs and might require giving up some property. Always talk with a bankruptcy lawyer before choosing this option.

Snowball or Avalanche Methods

For those who can pay more than the minimum payments then the Snowball and Avalanche methods offer do-it-yourself approaches. The Snowball method has you list debts from smallest to largest and pay minimums on all except the smallest. You put extra money toward the smallest debt until it's paid off and then move to the next smallest. This method helps you stay motivated with quick wins.

The Avalanche method focuses on paying off your highest-interest debts first. While it saves more money over time however it also requires more patience. Both methods need careful budgeting and commitment, but they let you control your debt repayment without involving others.

Learn More: High-Interest Debt? Try the Debt Avalanche Method

Choose a Debt Consolidation Company

It is really important to choose the right debt consolidation company when you are ready to consolidate your debt for successful debt consolidation. Here is what you need to look at when selecting a provider that will help you manage your debt well.

Check Their Reputation

First, look up the company's BBB rating. A very high BBB rating shows that the company is responsible. Make sure to read some reviews from satisfied and unsatisfied clients. Reliable providers tend to have most customers satisfied and have been able to repay the service. Also, watch how long they've existed in business. A long-time business has more experience helping people like you.

Look For Clear Communication

A good provider will explain everything: upfront costs and fees, interest rates and their process. Things should be explained to you simply. Avoid companies that try to push you into the process without knowing everything about costs or that won't give you a straight answer. If something makes you feel unsure, then keep asking questions until you understand it clearly.

Check Their Support Services

More than anything else, the best providers should help you consolidate your debts and offer you useful tools and resources that will keep you on the right track.

Look for companies offering:

• Free financial education to help you manage money better.
• Budgeting tools and counseling
• Friendly customer service that is easy to reach.
• Regular updates about your debt payoff progress

Consider Their Experience

Choose a provider that has helped many others in similar situations. Experienced companies know how to handle different types of debt and can create a plan that fits your specific needs. They should explain how they have helped others, show proof of their success rates and share stories about their typical customer and how many people successfully completed their programs.

Frequently Asked Questions

Conclusion

Debt consolidation is a useful tool if you use it right. Take the time to understand your options, check your situation and choose a reputable company to help you. For best results talk to a financial advisor who can guide you based on your situation.