If you’re feeling overwhelmed by your debts, you might consider a debt consolidation loan. But is this the right solution for you?
A debt consolidation loan is for personal use to pay off high-interest debt, most commonly credit cards. Consolidating debt allows you to pay off one or more credit card bills with a single loan, simplifying your payment plan. However, before agreeing to a new loan, it’s critical to understand debt consolidation and its benefits and drawbacks.
Here are some things to consider before you apply for a debt consolidation loan.
Debt consolidation is a process of paying several debts with a new loan or balance transfer credit card, which has a reduced interest rate. You obtain a low-interest installment loan for 24 to 48 months. The funds are used to pay off credit card balances and other debts. This gives you only the loan to repay, allowing you to combine payments into one monthly payment.
For individuals with many high-interest loans, debt consolidation is usually a sensible idea. However, it is not advisable to always opt for a debt consolidation loan. It is a good idea with benefits, but you should remember that it also has disadvantages.
Debt consolidation can provide many advantages, including faster, more simplified payback and cheaper interest payments. Here are some of the benefits:
1. Existing debts combined into a single loan will decrease the installments and interest rates you will deal with.
2. Consolidation can help your credit by lowering your risks of skipping or making late payments.
3. If your credit score has increased after applying for other loans, combining debts may allow you to lower your overall interest rate—even if you have low-interest debts.
4. Since future payments are stretched across a new and perhaps longer loan period, your total monthly payment will likely reduce when you consolidate debt.
A debt consolidation loan may appear to be a decent option to simplify debt repayment. However, there are some disadvantages to this strategy.
1. Additional fees, such as balance transfer, annual, settlement, and origination fees, might be charged while acquiring a debt consolidation loan.
2. When your credit score is too low to get the best rates, you can be left with a rate greater than the one on your present loans.
3. You may end yourself paying more in interest over time.
4. Consolidating debt can make payments easier, but it does not solve the underlying financial patterns that lead to the debts in the first place.
You can use a personal loan for nearly any purpose. But, if you’re considering taking it as a debt consolidation loan, here are certain circumstances to consider:
- You have a great credit score
- You have high-interest debt or a large amount of debt
- You have a repayment plan and strategy
- You have sufficient income to pay the increased monthly payment
Even though there are several obvious advantages to acquiring a debt consolidation loan to pay your debts, it may not be the best option in the following situations:
- You don’t have a plan to change your spending habits
- You have a bad or fair credit
- You don’t have many debts or loans
- You can pay your credit card debt over the next 6 to 12 months
You should avoid using your credit cards and making new charges until you have paid off the loan. With your debts paid off, it may be enticing to start spending. However, if you do not repay the loan first, you may end up with greater debt instead of less after the consolidation loan.
Once you obtain the loan, you must make a budget or review your current budget. Ensure your budget is adjusted so you can manage your loan payments and other responsibilities. It’s also a smart idea to include emergency funds in your budget.
Use the extra money you receive from a tax refund or another source to pay off the debt quicker. This is also why you should avoid loans with early payback penalties if you want to get out of debt as soon as possible.
Before signing the debt consolidation loan agreement, here are some questions to ask yourself and assess yourself that you are making the right decision in acquiring the loan:
- Can I afford larger loan payments to reduce the term?
- Will I stop spending once I have paid off my credit card balances?
- How much does this lower my interest rate?
Here are some questions to ask the lender before signing the debt consolidation loan agreement:
- What is the total cost of the loan? (This should include the principal, total interest charges, and the fees)
- Is there a way to lower the interest rate on loans?
- What will happen after I get the loan? How will you, the lender, send the fund?
- Is it possible to pay off this debt early without penalties or fees?
Should you get a debt consolidation loan? The answer to that question depends on your unique financial situation. But if you’re overwhelmed by your debts and think a debt consolidation loan could help you get back on track, you are encouraged to apply. Also, consult a financial advisor before making major decisions about your money.