- Consolidating higher-interest debt into a single loan with a lower interest rate can save you time and money.
- It's vital that you read the loan contract carefully to make sure you're receiving a fixed-rate loan.
- Loan consolidation only works if you can avoid taking on new debt.
When high-interest debt feels like a giant weight on your shoulders, you may benefit from loan consolidation. Here, we'll tell you how it works and how to decide if consolidating your debt in 2024 is a good idea.
When it's a good idea
The first sign that debt consolidation is a good idea is when you're treading water with high-interest loans, paying the minimum monthly payment but never seeming to get ahead. That's the way high-interest loans work. Unless you can come up with a chunk of money at once, it's difficult to dig your way out.
Consider this: If you make a monthly payment of $125 on a credit card with a $5,000 balance, carrying an 18% APR, it will take five years and two months to pay off in full. What's worse is that you'll pay $2,693 in interest. That's almost $2,700 you could have stashed away in an emergency fund or used to pay other bills.
As you consider consolidating debt, the goal is to find a personal loan with an interest rate lower than the average rate you're paying. Let's say you take out a personal loan with a 9% APR to pay off that same $5,000 credit card debt. By making monthly payments of $159, you could have the loan paid off in three years, and you would pay a total of $724 in interest. That's a savings of $1,969.
If you carry several high-interest debts, consolidating is even more effective and leads to even greater savings.
How it works
To consolidate debt, you take out a single debt consolidation loan to pay off existing debts. In essence, your existing debts get rolled into one easier-to-manage loan. Depending on the lender, either you use the proceeds of the loan to pay off the existing debt, or the lender does it on your behalf. In either case, what you're left with is one lower-interest loan to focus on and just one loan to repay each month.
When you take out a personal loan to consolidate debt, the entirety of the loan is deposited into your checking account at one time. Like with most other consumer loans, you make a fixed monthly payment until the debt is paid in full. And like most loans, you know how much your interest rate is going to be and the term of the loan. In other words, you know precisely when the debt will be paid in full.
What to be on the lookout for
While a consolidation loan can be a great way to get out of debt, it is not without risks. Here are a few to keep in mind.
American consumers owe a combined $1.08 trillion on credit card debt alone, with the average American carrying a balance of $6,365. Lenders know that, and less reputable lenders will exploit the fact. According to the Consumer Financial Protection Bureau (CFPB), one way shady lenders try to get one over on you is to offer you a "teaser rate" that only lasts for a certain number of months. After that, the interest rate jumps.
The best way to avoid a loan with a teaser rate is to work with a reputable personal loan lender. Read the loan contract from start to finish to make sure the rate is fixed and can never change.
Loans loaded with fees
The higher your credit score, the greater the odds you'll land a loan with no fees. That means you won't have to pay an origination fee or be subject to an early payment penalty. However, even if your credit score is not great, it's important to seek a loan with as few fees as possible. After all, those fees are rolled into your loan, increasing the amount you owe.
How successful your debt consolidation efforts will be comes down to how dedicated you are to getting out of debt and remaining out of debt. For example, if you consolidate all your high-interest debt this month but go out and put new charges on your credit cards next month, you're digging a deeper hole for yourself.
Be honest with yourself about how prepared you are to give up unnecessary spending as you improve your financial situation.
Many before you have used a consolidation loan to jettison old debt and start out fresh. You can, too. It may not be easy, but as you watch your overall balance drop each month, the satisfaction you'll feel will be worth the effort.
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