Debt as a societal challenge has grown leaps and bounds over the years. More and more people have been lured into a borrowing habit in the quest for a better life. However, the key to being financially independent is to manage your debts properly, and those who manage it successfully can take advantage of various debt products to leverage their financial position. However, those who exhibit poor management skills often end up in a debt trap, finding themselves burdened with multiple high-interest debts and bleak future financial prospects.
One of the best strategies that can be used to get out of trouble is debt consolidation. In this article, we will discuss what debt consolidation is and whether it is a good idea for you depending on your financial situation. If you’re looking for solid advice and guidance related to debt consolidation, you can also visit this page.
What is debt consolidation?
Debt consolidation, as the name suggests, is a financial tool through which you combine all your debts into a single unified debt with the aim of securing a lower rate of interest and better debt management. Debt management can be carried out in various ways, such as:
- Credit card balance transfer
- Personal loans
- Auto cash refinance
- Debt management services
- Home equity loans
- Borrowing from your retirement account
Advantages of debt consolidation
If you are wondering how debt consolidation can help you, here’s how:
1. Lowering monthly expenditures
Debt consolidation spreads your total debt over a more extended period of time. Thus, your monthly payments reduce. This is a win-win situation for two reasons.
If your income is stable and you do not face a financial crunch, you can make more than the required monthly payment and get out of debt faster.
On the contrary, if you face financial constraints, debt management can let you breathe easy with lower monthly payments. This helps you allocate more of your income to other necessities.
2. Better debt management
Managing multiple debts each month can quickly become a hassle. In this case, the chances of you missing out on payments are pretty high. This can lead to a dipping credit score.
A debt consolidation loan can help you get rid of multiple payments each month. You’d no longer need to keep track of several payments, and all you have to do is make a single unified payment each month. This helps you better gauge your financial capabilities and plan accordingly.
3 Lower interest rate
In most cases, you’d be able to secure a lower interest rate on your consolidated loan. If you have been regular in making repayments over the past 12-18 months, your credit score would likely have increased. With an improved credit score, you might be able to qualify for lower interest rates by most consolidation providers.
Similarly, when you opt for a credit card balance transfer, you will be able to take advantage of zero-interest for the next 18 months. You must aim to make maximum repayments during this zero-interest period. These repayments will go towards reducing your principal amount. Thus, even when the interest period starts, your interest will be calculated on a lower principal.
Thus, in both cases, you’d be able to save a lot on the interest front.
What to do after debt consolidation
Debt consolidation, without doubt, is a positive step towards developing better financial habits. However, most people often misunderstand the purpose of debt consolidation in the first place. It shall not be used as a temporary fix to financial problems. Rather, it shall be seen as an opportunity to solve bad financial habits permanently.
The most important thing to ensure post-debt consolidation is to make regular payments. After you have consolidated your debt, do not miss out on any payments. This can lead to two consequences:
- Several missed payments after consolidation can hurt your credit score. Moreover, your credit would have already taken a hit while securing a consolidation loan due to several reasons. In such a case, missing a payment can further dwindle your score. This can take years to overcome.
Do not take any other loan – this is by far the most essential rule of debt consolidation. You should not take any further credit in any form after you have consolidated your debt. Not only will this hurt your credit score, but it will also lead to another debt trap.
Things you need to be careful about
Like any other financial product, debt consolidation also has some constraints. Here are a few things you need to be careful about:
- Indirect costs – Apart from interests, there are other expenses that you must consider while opting for debt consolidation. These include closing costs, origination fees, pre-closure charges, etc. Depending on your lenders, these can range anywhere between 2-5% of your debt amount.
- Increased interest- Although the rate on interest in a consolidated loan reduces, the absolute interest you pay throughout the loan will increase. Remember, you would now be paying less interest each month for a more extended period. This would translate into a higher interest sum in total.
Whether debt consolidation is an ideal choice would depend on your financial situation and habits. If your financial rut resulted from a one-time mishap, debt consolidation is probably a good choice. It gives you an opportunity to start fresh and build a sound financial future.
However, if you are habitually a big spender, debt consolidation would just prove to be a temporary fix. You would soon find yourself in the same situation all over again – taking one loan to pay off the other and mounting several debts in the process.
If the benefits of debt consolidation outweigh the costs, it’s definitely a good choice. This will essentially happen if you have a good credit score. With a less-than-ideal score, your interest rates would not reduce much, while the closing costs and origination costs would remain the same. In such a situation, debt consolidation would have very little to offer to your financial situation. Thus, reach out to a financial possessional who can help you plan your finances better.