Thinking of Consolidating Debt? This Is the Most Important Question You'll Have to Answer
by Christy Bieber | Updated Aug. 13, 2021 - First published on July 5, 2021
You need to make sure that debt consolidation makes financial sense for you.
Debt consolidation can be a good way to take control of your finances.
One of the advantages of debt consolidation is that you'll simplify the process of becoming debt free. You will have only one loan to pay instead of having multiple loans that you have to pay each month. And you aren't going to have to decide which of your debts to focus on paying off first since there will just be this one loan to worry about.
If you make a smart debt consolidation choice, there's actually an even bigger benefit: saving money on the interest you pay on your debt.
But whether or not your consolidation loan saves you money -- or costs you money -- is going to depend on the answer to one big question: What type of debt consolidation will you use?
Which type of debt consolidation is right for you?
Before consolidating debt, research your options and choose the right type of debt consolidation.
There are some loans out there that are specifically marketed as "debt consolidation loans" to people who owe a lot of money. Often, they are expensive and don't have favorable terms. But there are also a number of potentially good options including:
Let's take a look at the pros and cons of a few of these options.
- Personal loans can be easy to apply for, quick to get approved for, and have lower interest costs than many credit cards. But they have higher interest rates than the starting rate for a balance transfer or the rate you'd pay with a home equity loan.
- Balance transfers are good for consolidating credit card debt. That's because you move the debt from your existing cards to a new balance transfer card. They can work well if you qualify for a balance transfer card offering a 0% promotional interest rate. The downside is your 0% rate is only good for a short time -- often around 12 months. So you could end up right back where you start with high interest costs after the initial offer period expires.
- Home equity loans are an option for homeowners who have a lot of equity in their homes. Upfront costs of loan approval can be very high, although interest rates are usually very low. The big downside is that you're jeopardizing your house by using it as collateral. You could also end up underwater (owing more than your home is worth).
Researching each of these loan options is crucial to making sure consolidation is actually a smart move. After all, you don't want to take out a loan to get your debt under control and then find yourself regretting it because it costs you more or makes it impossible to sell your home when you need to.
Other key considerations about your debt consolidation
The method of debt consolidation isn't the only thing that matters. The specific terms also affect whether debt consolidation is a good idea.
First and foremost, you'll want to make sure you're getting a lower interest rate than the debt you are consolidating. Otherwise, you will end up paying higher borrowing costs, which doesn't make sense.
You also need to consider the timeline for payoff. If you lower your interest rate by taking a home equity loan but you take 30 years to pay off your debt when you'd have had it paid off in two years if you stuck to the status quo, then you're in a worse position.
The same is true if you end up with a personal loan with a much longer payoff time, or if you can't pay off the balance transfer before the 0% rate ends. You could end up stuck with a large balance at a higher rate than you were paying before.
By carefully considering how you consolidate debt, as well as the terms, you can avoid undesirable outcomes and make sure your consolidation makes sense. Take the time to research your options carefully and do the math before you move forward so you aren't left with regrets.
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