As ironic as it may sound, but sometimes taking on more debt to get out of existing debt may be the only viable solution left. Debt consolidation can be used as a last resort when one is already drowning in debt, getting behind on making payments and when creditors are unwilling to show any mercy.
So What Is Debt Consolidation?
In the most basic terms, debt consolidation is taking out a loan to pay previous debts. It is combining all your liabilities into one large debt and then paying it off on monthly basis.
While it may not be the ultimate solution to debt, consolidation gives you more time to pay it off. You may find yourself considering this option when the payment dates are drawing near, and your payment plan is not working out as well as you wanted it to.
How Does It Work?
The process of consolidating your debt will often depend on your financial situation. For small amounts of money, you will only need to apply for the loan and start paying it off in agreed periods, usually monthly. Typically, these are unsecured.
If you are deep into debt, you may consider taking out a home equity loan. It involves putting your home or other properties as a collateral. This is usually very risky as you may lose your home if you default on payments, however, it usually comes with attractive interest rates.
Does Debt Consolidation Affect My Credit Score?
According to Chron, taking a debt consolidation loan will have a positive result on your credit score. Even if you have a new loan on the record, all the other loans are marked as fully paid which improves your rating. You will, however, have to pay off the consolidation loan on time to maintain the score.
On the other hand, Credit Sesame points out that opting for a credit card balance transfer will see your score suffer unless you make sure that you pay off the balance promptly.
What Kind of Debt Can Be Consolidated?
While most unsecured debts can be consolidated, secured debts can only be consolidated under exceptional circumstances.
In most cases, consolidation loans are taken to pay off high-interest credit card debts unless the bank or financer requires that property is posted as collateral which is not common. For instance, retail card bills can be consolidated unless the store has taken a security interest in all the goods or services bought with the card.
Student loans can also be consolidated unless they are insured by the federal government in which case it can garnish an amount of your disposable income without a prior court judgment.
Other loans that can be consolidated include unsecured personal loans, lines of credit, payday loans, gas card bills, back rent, medical, hospital and utility bills.
What Are The Pros And Cons Of Debt Consolidation?
The most obvious benefit of consolidating debt is the extension of time to pay it. When you have five debts to pay by the end of three months, you can combine them and pay them off in a year or so.
Ideally, debt consolidation is also essential in cutting down the costs; paying off one debt with one interest is much better than paying off five others, each with its own rate of interest and late fees.
On the other hand, consolidating debt is just as good as postponing it. You may also be tied up in years of repayment. Also, some consolidation loans may require you to attach your property as security. If you fall back on the repayment, you may lose important assets including your home.
Does It Make Sense To Consolidate Debt?
Well, there is no easy answer to this. Every situation is different; however, a little math may help you answer this question. Calculate how much total interest you owe right now on your current outstanding credit cards debts and how much time will it take to pay them off. Compare this information with the interest rate being offered, the total length of time required to pay off and the change in minimum monthly payments if you go for debt consolidation. Sometimes, it’s just better to pay off credit cards as you may end up paying more in the long run even at a lower interest rate offered by debt consolidation.
However, what if you are always behind and those late fees are killing you? In that case, it makes perfect sense to combine all the debts. Being behind on just one payment is better than being late on, let’s say, four payments.
Also, when it comes to negotiating with creditors, some debt consolidating companies are able to get a better deal. They are able to knock a few dollars off from the total debt with their aggressive negotiating skills.
Things To Note Before Consolidating Your Debt:
1. Debt consolidation does NOT get you out of debt. It just extends the time for repayment.
2. Not all debts can be consolidated. If you are planning to take such a loan on secured debt, make sure you carve out a plan with your creditors before applying.
3. Go for a lender that does not pull a hard inquiry; it will hurt your credit score.
4. Be sure that you are going to consolidate the right debts. Pay off the ones with high interests first then work on the ones with lower interests.
How Is Debt Consolidation Different To …?
1. Debt Settlement
Debt settlement involves negotiating with a creditor to forgive a certain percentage of the total amount owed in exchange for the payment of debt in a lump sum. While this actually gets one out of debt, consolidation just adds them more time to pay it.
2. Filing For Bankruptcy
This involves declaring that you are unable to pay off your debts. The federal government protects you from creditors, and most unsecured debts can be dropped. It takes a toll on your credit score but gives you a fresh start.
3. Credit Counseling
It is the process of seeking professional assistance from a credit counselor to develop a debt repayment plan. They usually help in negotiating a lower interest rate with creditors. In some cases, the counselor may need you to make regular payments to them (usually monthly). Distributing those funds to the creditors then becomes their headache. It removes the burden of managing debt from your hands.
4. Debt Refinancing
When you refinance a debt, you replace it with a new one (which can also be consolidated). The point of refinancing is to get better terms such as lower interest rates and even the elimination of late payment fee. You can also refinance to lower the required amounts of monthly repayment.
5. Snowball Debt Repayment
Debt repayment snowball is a debt reduction strategy that involves paying off smaller debts first while just making minimum payments on the larger debts. With this approach, you will be able to knock off smaller debts quickly and then using its payment towards the larger debts.