Debt consolidation rolls multiple debts into a single payment. It can work if your debt isn’t excessive and you have good credit and a plan to keep debt in check. Debt consolidation rolls high-interest debts, such as credit card bills, into a single, lower-interest payment. It can reduce your total debt and reorganize it so you pay it off faster. If you’re dealing with a manageable amount of debt and just want to reorganize multiple bills with different interest rates, payments and due dates, debt consolidation is a sound approach you can tackle on your own.
How does debt consolidation work?
There are two primary ways to consolidate debt, both of which concentrate your debt payments into one monthly bill:
- Get a 0% interest, balance-transfer credit card: Transfer all your debts onto this card and pay the balance in full during the promotional period.
- Get a fixed-rate debt consolidation loan: Use the money from the loan to pay off your debt, then pay back the loan in installments over a set term.
Two additional ways to consolidate debt are taking out a home equity loan or 401(k) loan. However, these two options involve risk — to your home or your retirement. In any case, the best option for you depends on your credit score and profile, as well as your debt-to-income ratio.
Benefits of debt consolidation
1. Pay down multiple debts faster
With debt consolidation, you can clean up multiple financial debts quickly and efficiently, thus saving both cash and time in the process. The key money-saving feature usually comes from paying a lower rate of interest on a consolidated loan or zero-interest credit card, compared to the higher interest rates that come with traditional credit cards, personal loans and student loan debt.
Lower interest rates have a ripple effect on high personal debt:Since you’re paying a lower rate of interest, you’re steering more money into repaying debt principle. For example, using a consolidated loan with an interest rate of 8% against thousands of dollars in credit card debt with a 16% interest rate saves the borrower substantial money over the long term, if he or she used the consolidated loan to strictly pay off other higher-interest rate debt.
2. You’re simplifying the debt repayment process
The term consolidation means gathering multiple things together in one bundle and that’s exactly what loan consolidation can do. Instead of having to keep track of six or seven different credit and loan accounts that required on-time monthly payments, you only have one payment to make with a consolidated loan.
It’s much easier to manage your debt with a single payment, as opposed to half a dozen payments, leading to fewer missed payments, which saves money on late payment fees and the higher rates that often accompany missed or late monthly debt payments.
3. You’ll deliver a positive charge to your credit score
Another benefit of consolidating your debt into a single monthly loan payment is that you’re staying well ahead of potential credit problems. With multiple monthly payments, you could easily miss a payment and fall behind. Missed payments, however, have a significant impact on your credit score – 35% of which is calculated on making on-time monthly credit and loan payments.
By making your loan payment on time, you’ll be improving your credit score – not damaging it.
Keys to Successful Debt Consolidation
When your personal finances teeter on the brink, your first instinct might be to do something drastic. Freeze your credit cards in a block of ice. Vow to never eat out again. Forgo your Netflix subscription.
These tactics may help, but financial experts say paying off debt requires a more comprehensive plan. One common strategy is debt consolidation, rolling multiple debts into a single loan or credit card at a lower interest rate.
“Consolidating debt into one spot can be empowering and helpful from a psychological standpoint because it feels manageable,” says Mathew Isaac, associate professor of marketing at Seattle University’s Albers School of Business and Economics. Consolidation works best for high-interest-rate debts such as credit cards.
Make a realistic budget
“In order for consolidation to work well, there has to be a clear plan of attack.
A basic budget allocates money for debt payments, an emergency fund and contributions to retirement savings, but that isn’t enough when consolidating, says Lara Lamb, a certified financial planner at California firm Abacus Wealth Partners.
Successful budgeters avoid adding debt by accounting for infrequent expenses, such as car registration fees, as well as times of the year when expenses run high, like the holidays. They also leave room for fun.
“People will go on a spending ‘diet’ and then feel like they’ve restrained themselves for so long that they go out and splurge,”. “A realistic budget gives you enough to spend on things you value and you love.”
Quit using your cards
A cardinal rule of consolidation is not using your credit cards as you pay off debt.
People cut up their cards, lock them away or freeze them in ice, methods that seem extreme but experts say can be effective. Such tactics are known as “commitment devices” and help people achieve long-term goals.
To stay committed, write down why you want to be debt-free and how often you will make payments, and set periodic reminders to check your progress.
Locking away cards doesn’t mean closing accounts, which could hurt your credit. The one exception to the no-use rule is a nominal charge on your card every few months — paid on time and in full — to keep the account active and your credit intact
Debt consolidation loans typically come with lower interest rates than credit cards, and you can borrow more money. Rates depend on your credit profile and how much debt you have. A lender that sends money straight to your creditors can remove the temptation to spend that cash instead of using it to pay off debt.
The Bottom Line
Replacing several multiple-rate loans with one, the fixed-rate monthly payment can simplify life. Don’t consolidate just for convenience, however. Unless you’re overwhelmed by multiple payment dates, the ease of a single monthly payment alone is a sufficient reason to consolidate debt.
Check your options today. Contact Empire Broking today.