Consolidating debt can be a critical financial tool to reduce your loan or credit card payments, boost your credit score, and give you more money in the bank. Read on for an FAQ that outlines everything you need to know about debt consolidation loans.
What is Debt Consolidation?
Debt consolidation means combining multiple loans or consumer debts, such as credit card debt, and paying it all off via a new, single loan. The new loan should offer more favorable terms: typically giving the borrower a lower interest rate, or lower monthly payments.
Why Take Out a New Loan?
There are two major benefits of a debt consolidation loan. First, consolidating multiple sources of debt into a single loan simplifies the repayment process. Instead of paying off many different loans or debts every month, you’re just making one payment on one loan.
The other key benefit of debt consolidation is cost. Typically, borrowers will consolidate debt when they know they can get a better interest rate on the new loan. While a lower interest rate every month doesn’t reduce your principal, it does mean less money spent on interest payments – which can make a big difference to the total cost of your loan or credit card repayments.
On the other hand, it’s also possible that a debt consolidation loan will offer lower monthly payments, without affecting your interest. While this doesn’t change the total cost of your loans, it can help borrowers to manage the monthly financial obligation of their debt.
Who Should Consolidate Debt?
Debt consolidation may be a good option for anyone with high-interest debt. If your current interest rates are topping over 10% on a loan or over 16% on credit card debt, it could be worthwhile to look into a debt consolidation loan – depending on your credit score. Having a good credit score (670 or above) means you are more likely to qualify for favorable terms and a low interest rate on a debt consolidation loan.
Taking out a loan to consolidate debt may also be a good option for credit card holders who are in the habit of only making minimum monthly payments, rather than paying off their entire balance. Like all personal loans, a debt consolidation loan will have a set repayment period: imposing a deadline on the borrower, which could be useful if you need additional motivation to pay off your debt.
What Are the Risks?
If your credit score is poor, it could be risky to get a debt consolidation loan – you don’t want to end up with a higher interest rate than what you’re already paying. Only consolidate debt if doing so will lower your final cost; which may mean you need to calculate the requisite fees of a consolidation loan to decide which option is best for you: your credit union or bank should be able to help you map out the numbers and see what makes the most sense.
Student loans sometimes come with their own special logistics, so consolidating these takes more caution. For example, there was recently a COVID-19 payment pause on student loans. Under a consolidated loan, the borrower may have missed out on that benefit. If you’re interested in student loan consolidation, talk with your lender about how to secure an advantageous plan.
It’s also important to consider where you go for your loan. There have been reports of debt consolidation loan scams, in which companies charge upfront fees or claim to settle your debt for a lower amount. If you get an offer that looks too good to be true – it probably is!
How to Apply?
The process of applying for a debt consolidation loan is similar to the application process for any personal loan. Check your credit score to make sure you can qualify for a favorable interest rate, then shop around with reputable lenders – comparing interest rates, fees and terms, and monthly payments.
When it’s time to apply, be ready to share your Social Security number, contact details, and the details of your current loans and consumer debt. It’s also a good idea to come prepared with any remaining questions you have. The right lender will be able to chat you through all the details.