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According to Experian 2021 Credit Report, US consumers with credit card debt have an average balance of $ 5,525, while the average credit card interest rate is currently well above 16%.
For those in arrears, high debt and a high Annual Percentage Rate (APR) can combine in the worst possible way, often creating a cycle of high interest debt payments that consumers cannot escape. And, even for those who can Keeping up with monthly payments, too much credit card debt can prevent them from reaching other financial goals, like saving for the future.
Either way, debt consolidation offers a way out of credit card debt that is much less serious than bankruptcy. You just have to be prepared to create a plan and stick to it until you are debt free. If you want to get out of debt for good, read on to find out how debt consolidation can help.
If you’ve been trying to plan your way out of debt or make more money but nothing seems to be working, debt consolidation might be the answer you’re looking for. With debt consolidation, you will essentially be swapping out the loans and credit card balances you have for a new loan product with better rates and terms, thus reducing your monthly payments or making it easier to allocate more. from your money to reducing principal on debt, or both.
Essentially, with a debt consolidation, you take out a new loan and use the proceeds from that new loan to pay off all of your old debts, then make monthly payments only on the new loan. Broadly speaking, there are three financial products that consumers use for debt consolidation:
- Debt Consolidation Loans, also called personal loans, allow you to refinance your debts into a new loan with a fixed interest rate and fixed repayment term.
- Balance Transfer Credit Cards allows you to consolidate your debt on a new credit card that offers 0% APR for a limited time.
- Home equity loans can help you consolidate your debt into a new loan product backed by the value of your home.
Whichever product you decide to use, remember that debt consolidation only really works if you stop taking on more debt. If you consolidate debt with a personal loan or credit card with balance transfer and keep charging more for purchases on other lines of credit, debt consolidation is probably a waste of time.
Debt consolidation may or may not be a good idea. It all depends on how seriously you take the process and whether you have the discipline to carry it out.
As an example, let’s say you currently have $ 5,525 in credit card debt at an APR of 19%. In this scenario, you could pay $ 100 per month for this debt for 133 months – or more than 11 years – before it is paid off. During this period, you would have paid more than $ 7,701 in interest.
But what if you consolidate that $ 5,525 of debt into one personal loan? Although personal loans vary, most allow you to borrow money for two to seven years. Personal loans also come with fixed interest rates, fixed repayment terms, and fixed monthly payments.
In this example, you may qualify for a 60-month personal loan with an interest rate of 7%. In this case, you would pay off your balance with a monthly payment of $ 109 for five years (60 months). During that time, you would pay approximately $ 1,039 in interest payments. That’s a huge savings of over $ 6,000.
You can also consolidate your debt with a credit card. However, it’s important to note that while balance transfer credit cards offer an introductory 0% APR on transferred balances, the longest possible term currently offered is 21 months. After that, your interest rate will revert to the normal APR, which will always be high.
For this reason, a credit card balance transfer is only a good idea when you have an amount of debt that you can pay off during the card introduction period. If you need more time to get your debt under control than a balance transfer allows, you should consider a personal loan instead.
Finally, you can also consolidate your debt with a home equity loan that uses your home as collateral. In many cases, this can be a good idea, as home equity loans can come with low fixed rates as well as a fixed monthly payment and a fixed repayment term. Remember, you need good credit to get a home equity loan, and you can lose your home if you default on your payment.
But, in either of these cases, if after consolidating your debt, you overspend and accumulate an additional $ 5,000 in debt on the same original credit card that you used before that you can’t afford to pay off. that $ 100 in monthly payments on that debt, you end up paying an additional $ 4,985 in interest. Add that interest to the extra $ 5,000 of debt and your situation will be worse than you started with. This is why it is so important to stay disciplined and not keep spending more than you have when pursuing debt consolidation.
There are other debt consolidation options you can consider, some of which offer help from third party companies. For example, you might consider signing up for a Debt Management Plan (DMP), which takes place when a credit repair agency helps you negotiate interest rates and pay off your debts over a period of time. determined.
Just note that DMPs are not for everyone, and there is nothing credit repair agencies that offer DMPs can do that you cannot do on your own. Additionally, a number of credit repair agencies have gained a bad reputation, so be sure to do plenty of research before you embark on this route.
Another alternative is debt settlement, which is a process that helps you pay off your debts for less than you owe. However, it is essential to know that debt settlement companies ask you to stop paying your debts while they are working on your behalf. Not surprisingly, this can cause considerable damage to your credit score that can last for years.
Debt management becomes considerably easier when you have a reasonable interest rate and a monthly payment that matches your income. A big part of what debt consolidation does – it helps you transfer high-interest debt to a new financial product on better terms.
Another benefit of debt consolidation is that you can reduce the monthly payments you make. If you’re currently trying to cope with five or six credit card bills, consolidating debt with a personal loan company or peer-to-peer lender can help you make the jump to just one payment per month. .
With that in mind, several factors can determine if debt consolidation is right for you. These include:
- Your solvency: You will need good credit or better to qualify for a personal loan at the best rates and conditions. If your credit is poor, you may not be eligible for a new loan with better rates than you currently have.
- Your desire to repay debt: Debt management takes time and effort, and full debt repayment can take years. If you are not serious about debt consolidation, a debt consolidation loan may not leave you in the best position.
- Your ability to avoid new debt: For your debt consolidation to be successful, you must stop accumulating more debt. While you are paying off your debt consolidation loan, you should only use cash or debit. At the very least, you should use credit sparingly.
So, should you consolidate your debts? If you pay credit cards with high APRs, debt consolidation may be just what you need. Remember, you will only pay off your debt if you make a plan, and most importantly, if you stick to it. If you take out a personal loan and continue to take on credit card debt, you could end up worse off in the long run.
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