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If you want to reduce – or simplify – your monthly debt payments, debt consolidation may be right for you. It can help you organize your finances and make it easier to pay off your debts. With debt consolidation, you’ll combine all your debts into one payment, so you won’t have to worry about multiple payments, interest rates, and due dates.
Like any other financial strategy, debt consolidation is not for everyone. Here’s what you need to know about debt consolidation and its impact on your credit.
If you are considering a personal loan to consolidate your debts, Credible allows you compare personal loan rates from various lenders in minutes.
How does debt consolidation work?
With debt consolidation, you combine multiple debts into one manageable payment, ideally with a lower interest rate. It can help you simplify the debt repayment process and save on interest. A debt consolidation loan is a type of personal loan.
If you’re overwhelmed with multiple debts, such as unpaid credit card balances, medical bills, or tax debt, debt consolidation can be a great solution. You won’t have to keep track of different payments and interest rates, so you can pay off your debt with less confusion.
Debt Consolidation Options
You can consolidate your debt in several ways, including:
- Personal loan – You can take out a personal loan at a lower interest rate than all or most of your other debts and use the funds to pay off what you owe. Many financial institutions, such as banks, credit unions, and online lenders, offer debt consolidation loans.
- Loan from friends and family — If you have a loved one with extra money, you might consider asking them for a low-interest loan. You can use the funds to pay off your debts and repay a family member or friend in one monthly payment. Just make sure the repayment plan is written down so everyone is on the same page.
- Credit card balance transfer — Once you open a balance transfer card, you transfer your current credit card debt to it. In most cases, the balance transfer card will come with a promotional APR of 0%. If you pay off your debt in full during the promotional period, you can avoid interest charges. Otherwise, you will have to pay off the remaining balance at the card’s regular interest rate. You will generally need good to excellent credit to qualify for a 0% introductory APR.
- Home equity loan or HELOC — A home equity loan or home equity line of credit (HELOC) lets you borrow money secured by your home. It can give you the money you need to pay off high-interest debt at a lower interest rate. But if you can’t pay it back, your lender can foreclose on your home.
- Automatic refinancing with withdrawal — If you have equity in your vehicle, an automatic cash refinance replaces your current car loan with a new, larger loan – you can use the difference to pay off your debts. To qualify for a cash auto refinance, your vehicle must be worth more than the remaining balance of your auto loan.
- Retirement loan — If you have a retirement account like a 401(k), you can withdraw money from it to consolidate your debts. You’ll pay interest to yourself, and loan repayments will usually come from your paycheck. Keep in mind that once you withdraw funds from your retirement account, you will lose the power of compound interest on that amount. And, if you fail to repay the loan, you could face a tax bill on the amount you withdrew from the retirement account.
How Debt Consolidation Can Affect Your Credit
Debt consolidation can have both positive and negative effects on your credit.
- Serious inquiries can lower your credit score. When you apply for a balance transfer card or personal loan to consolidate debts, the lender will do a thorough investigation of your credit. This can cause a temporary drop in your credit score.
- Your average credit age will decrease. As your credit accounts age and show a history of on-time payments, your credit score will likely increase. By opening a new account, you will reduce the average age of your account, which in turn could lower your credit score.
- Your credit mix will become more diverse. Your credit mix refers to the types of accounts you have, such as credit cards, loans, or a mortgage. Since lenders prefer to have a variety of accounts, opening a new credit card or personal loan can boost your credit score.
- You reduce your credit utilization rate. Your credit utilization rate is the amount of revolving credit you are using divided by the amount of revolving credit you have. Since a new debt consolidation account can increase your available credit, it can lower your ratio and improve your credit score.
- Punctual payments can improve your payment history. If you make timely payments on your new debt consolidation loan, your credit score will gradually improve. Payment history is the most important factor in determining your credit score, so make sure you never miss a payment.
When it makes sense to consolidate your debt
Debt consolidation isn’t for everyone, but it’s a great option if you’re currently struggling to keep up with monthly payments. If you are able to secure a lower interest rate than your current debts, you can save hundreds to thousands of dollars in interest over the life of your loan. However, if your repayment term is much longer, you could still pay more interest overall. Consider these factors before consolidating your debt.
Debt consolidation can also be worthwhile if you know you can stick to your budget in the future. If you pay off your debts with a debt consolidation loan, but immediately start racking up credit card debt afterwards, you’ll find yourself stuck in the same cycle again.
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How to start
If you decide to go ahead with debt consolidation, check your credit score first so you know where you stand and what types of loans and credit cards you might qualify for. Next, make a list of all the debts you would like to consolidate.
Next, determine which route to debt consolidation you want to take. Shop around and compare all your options to find the best rates. After choosing the right path for your situation, make sure you make your payments on time.
If a debt consolidation loan isn’t right for you, you can look to other options.
- Create a budget — Sometimes the easiest way to pay off debt is to create a budget and stick to it. You can choose from many different types of budgets depending on your needs.
- DIY Debt Repayment Strategies — You can use the snowball or debt avalanche method to pay off your debts yourself. While the debt snowball method focuses on paying off your smallest debts first, the debt avalanche strategy aims to help you save the most on interest by paying off first. your debt with the highest interest rate.
- Debt settlement — Debt settlement is when you negotiate with your creditors to settle less than you owe. You can negotiate yourself or hire a professional debt settlement company to do it on your behalf. Be aware, however, that debt settlement can hurt your credit.
- Debt management plans — Offered by credit counseling agencies, debt management plans are designed to help those with a lot of unsecured debt. A credit counselor will negotiate interest rates, monthly payments or fees with your creditors. Once they do, you will make a payment to the credit counseling agency, which will use the money to pay your creditors. Debt management plans can also negatively affect your credit if you end up changing the terms of your agreements with creditors.
If you’ve decided to use a personal loan for debt consolidation, visit Credible for compare personal loan rates.