Managing all your debts, with multiple due dates, interest rates, and minimum payment amounts, can be very difficult to keep track of. Missing a payment can hurt your credit score and your chances of borrowing money in the future.
That’s why consolidating all your monthly bills into one payment with a new personal debt consolidation loan can be a great way to simplify your financial life, keep your credit strong, and make it easier to pay off what you owe every day. month. Of course, you should continue to pay all your bills on time until you have simplified the payment setup with your new loan.
What is a personal debt consolidation loan?
Using a personal loan to consolidate debt involves paying off all your credit cards, loans, and other debts with the loan funds, then making a manageable payment on your personal loan until it’s paid off. .
If you have several types of debt, a personal loan can help you keep them up to date. Being late on any of your payments, whether for a credit card or a student loan, can crush your credit score. It could also hamper your chances of borrowing money in the future.
Consolidation loan vs personal loan
Although often referred to by its own name, a debt consolidation loan is simply a personal loan used to consolidate debts.
A personal loan is a lump sum of money that can be used for various purposes, such as making a major purchase. You repay the loan in monthly installments for a fixed period. Personal loans are generally unsecured, which means they have no collateral as security.
Advantages of debt consolidation with a personal loan
Debt consolidation with a personal loan has several advantages that make it an attractive option:
- One monthly payment: It can be difficult to keep track of multiple monthly debt payments. A debt consolidation loan simplifies your finances and allows you to make a single monthly payment.
- Lower interest rates: Although personal loans often come with higher rates than secured loans, they can have lower rates than credit cards.
- Pay off your debts faster: With a lower interest rate, you may be able to save money and pay off your debt sooner with a personal loan.
- Improve your credit score: Using a personal loan to consolidate debt can improve your credit score by increasing your available credit, which lowers your credit utilization rate.
Disadvantages of debt consolidation with a personal loan
Although a debt consolidation loan has its advantages, there are also disadvantages that you should consider:
- Potentially high interest rates: Personal loans generally have lower interest rates than credit cards, but for borrowers with poor credit, personal loan rates can exceed 30%.
- Additional upfront costs: When you take out a personal loan, you may be subject to loan origination fees. Other common charges may include prepayment penalties and late payment charges.
- Could encourage more spending: Debt consolidation does not solve the fundamental problem of why you got into debt. If you consolidate your credit card debt with a personal loan, you may be encouraged to start accumulating new debt.
When to take out a personal loan for debt consolidation?
Having high interest rate debt, such as credit card debt, could make you a good candidate for a debt consolidation loan, as personal loans tend to have lower interest rates than credit card. You might be a good candidate for a personal loan if:
- You have strong credit: The better your credit, the more likely you are to qualify for a loan at the lowest interest rate. The lower your interest rate, the less you have to pay on top of the money you borrow.
- You have a large but controlled debt: If you have a large amount of debt but are able to make at least minimum monthly payments, a personal loan may be best for you.
- Your expenses are under control: A personal loan will not help you if you do not control your expenses. In fact, it could put you in even more debt. Before getting a personal loan, review your finances to make sure you can afford the loan and pay off your debt.
You may still qualify for a personal loan if you don’t have good credit, but you may face higher interest rates. If the personal loan rates available to you are higher than what you are currently paying on your debt, try other methods of settling your debt. Once your credit improves, you may qualify for lower interest rates on debt consolidation loans.
Other Ways to Consolidate Debt
If a personal debt consolidation loan isn’t working for you, there are several ways to consolidate your debt, including:
Home Equity Loan
If you own your home and your mortgage debt is less than the value of the home, you may be able to take out a home equity loan and use it to pay off your outstanding debt. A home equity loan is a type of second mortgage that lets you borrow against the equity in your home. You can use the lump sum you receive from your home equity loan to pay off all your outstanding debts, then make a single payment on the new loan each month.
For home equity loans, your home is secured. As a result, the lender views your loan as less risky, which means interest rates are generally lower than unsecured loans such as personal loans. But keep in mind that if you fall behind or fail to repay your home loan, you could lose your home. Calculate the equity in your home to see if you would qualify to borrow enough to cover your outstanding debt.
Credit cards with balance transfer
If you want to manage a few credit card balances, you can try a balance transfer credit card. Many cards offer 0% APR for a fixed term, usually between 12 and 21 months.
It’s a great way to transfer all of your existing credit card debt into one manageable payment each month. Keep in mind that if you have a lot of credit card debt, you might not be approved for a balance transfer for the full amount you need. This means you could pay off your new card balance as well as any cards that couldn’t be transferred.
If you don’t pay a balance transfer credit card before the end of the 0% APR period, the card issuer starts charging interest.
Debt repayment strategies
If you don’t qualify for a new loan or credit card transfer, you may need to manage your debt differently. If you haven’t already, start by organizing your debt on a spreadsheet. Write down each lender you owe money to, your current interest rate, the amount you owe, and your monthly due date. From there, you can try a few debt management methods:
- Debt Snowball: This method focuses on paying off your smallest debt first. While making minimum payments on all other debt you have, you spend all your extra money on the debt with the lowest balance. Once that’s paid off, you then focus on allocating all of your extra money to the lower balance. Do this until all your debts are paid in full. The advantage is that you will see results quickly. The downside is that you might end up paying more interest on other debts that charge higher rates.
- Avalanche of debt: This method focuses on paying off the debt with the highest interest rate first. You make minimum payments on all your other debts, then put all your extra money on the debt with the highest interest rate. Do this until the debt is paid off, then move on to the debt with the highest interest rate until all of your debt is fully paid off. Although you can save more money by paying off the higher interest debt first, you might not see results as quickly as with the debt snowball method.
The bottom line
A personal loan could be a great way to consolidate your debt, but it’s not necessarily the right method for everyone. Examine your debt situation and see if a personal loan would work better. Otherwise, try methods such as a home equity loan or a balance transfer or debt management strategy.