Understanding the pros and cons of debt consolidation is pivotal when reviewing your options. It’s indeed a tough situation to get saddled with debts. There’s always anxiety every time the repayment schedule is coming. If you fail to make payments on time, there’s the chance of getting a low credit score that can mess up your ability to secure a loan in the future.
That’s why it’s not surprising that many people who are living in multiple debts explore options like debt consolidation to pay off their financial obligations faster. Learn more about debt consolidation and its advantages and disadvantages in this blog post.
What is Debt Consolidation?
Debt consolidation means taking out a new loan to combine multiple debts from several creditors into a single debt with a lower interest rate and monthly repayment. People use this form of financing to deal with consumer debts, such as credit card balances, student loans, and other financial liabilities.
Credit unions, banks, and credit card companies offer debt consolidation loans. If you’re not qualified to take out this form of financing from these institutions, you can go to private lenders or companies that specialize in debt consolidation services.
Advantages of Debt Consolidation
Debt consolidation seems like a good option to get out of your debts faster. Here’s a list of the pros of obtaining a new loan to consolidate your debts.
One great advantage of debt consolidation is that you won’t have to worry about paying multiple debts to different lenders. Taking out a debt consolidation loan allows you to merge your financial liabilities into one debt payment. In this way, you can manage your finances well and know how much money to save every month to pay your new loan.
Repay Your Debts Faster
You can pay your debts faster if you get a debt consolidation loan. This benefit is especially true with someone whose credit card debt is already mounting up. As you may well know, there’s no fixed timeline for paying off credit card balances. There’s a set payment schedule and end date of your financial obligation with a debt consolidation loan.
Lower Rates of Interest
There are types of consumer debts that have high-interest rates. For example, credit cards can have interest rates ranging from 18% to 20%. Loans intended for consolidating debts, on the other hand, have an average of a 10% interest rate. So, if you opt to consolidate your debt, there’s a chance that you can get a loan with a reduced interest rate and monthly payment.
However, you must keep in mind that the interest rates vary by lender and loan product. Your credit score also significantly impacts how much interest you have to pay for the loan.
Good for Improving Credit Score
Personal loans meant for consolidating debts may boost your credit score because of their fixed repayment schedule, enabling you to pay the loan on time. And, when you make timely loan payments, you can register positive marks on your payment history.
Moreover, for debts related to credit cards, you can have a strong credit history and better credit utilization if you choose to keep your cards open after paying them off through a debt consolidation loan.
Disadvantages of Consolidating Debts
Aside from the benefits, there are also disadvantages of debt consolidation loans. You need to be aware of them so that you won’t regret your decision later.
It’s Not the Ultimate Solution to Your Debt Woes
Yes, you heard that right. Debt consolidation is not a silver bullet to your debt problems. If you don’t have proper financial and debt management, you’ll likely get burdened with debts sooner or later.
If you don’t want to avoid debts, make sure to have a robust financial plan, and start saving money to prepare for sudden expenses or emergencies. Also, check your lifestyle choices and live according to your means.
There are Fees
Taking out a debt consolidation loan may have some fees. Examples of the upfront costs that you need to pay are origination fees, annual fees, balance transfer fees, closing fees, early cancellation fees, and late payment fees. You should inquire about such fees to your lender before you apply for the loan.
Interest Rates May Be Higher Than You Think
As mentioned earlier, your credit score may impact how much you pay for the interest. Also, if you choose a longer repayment term, you may pay more for your debt consolidation loan’s interest. So, make sure to have a good credit score and pick a loan term that suits your needs to avoid paying high interest for your loan.
Examples of Debt Consolidation Loans
There are various types of loans meant for consolidating multiple debts. Keep on reading to know more about them.
Personal loans are a form of installment loan that you can use for various purposes, including consolidating debt. Traditional financing institutions and private lenders offer this type of loan. People with low scores on their credit can also avail of personal loans, but such bad credit loans have higher rates of interest.
Home Equity Loans
If your home already has significant equity, you can take advantage of that to pay off your debts. Home equity loans have lower interest rates than other loans because there’s collateral (your house) offered as security for the loan. However, make sure to pay the loan on time to avoid losing your house.
Balance Transfer Credit Cards
You can also opt for balance transfer credit cards to get out of your current debts. This option comes with a 0% introductory annual percentage rate for a year or more. However, there are upfront costs and penalty fees that you need to keep in mind when taking out balance transfer cards.
Now you know the pros and cons of getting debt consolidation loans. If you want to merge your debts into a single debt, this financing option is good for you. Just be aware of ancillary fees and high interests when considering taking out this loan. Examples of loans that you can use for debt consolidation are personal loans, home equity loans, and balance transfer cards.
You can contact debt.ca if you need help regarding your debts. They have credit counsellors that can give you advice on how to manage your finances and financial liabilities.