Is Consolidating Debt a Good Idea?
If you have several high-interest loans that you’re currently repaying, you may be considering consolidating them with a debt consolidation loan. But, is this a good idea?
There are several important benefits of debt consolidation to consider. Depending on your situation, you may be able to save money, lower your monthly payments, or simplify your finances.
What Is Debt Consolidation?
Debt consolidation is when you take out a loan to pay off all of your existing debts. Most people consolidate their debt to save money on interest, but it may also be possible to structure a debt consolidation with a longer repayment term to lower your monthly payments.
You could use a personal loan to consolidate debt, but San Francisco Federal Credit Union also offers a special debt consolidation loan. This loan can be used to consolidate many different types of debts, including:
- Auto loans
- Store cards
- Credit cards
- Payday loans
- Medical debt
- Student loans
- Pawn shop loans
- Collection agency debts
Consolidating your debt is very easy to do. You simply apply for a personal loan or debt consolidation loan. If you’re approved, you’ll be issued a lump sum for the full amount. You then use the money to pay off your current debts.
An important advantage of debt consolidation loans to consider is that they have fixed interest rates. That means the rate you will pay is locked in when the loan is created and will not change. Therefore you won’t have to worry about any future rate increases.
Is Debt Consolidation a Good Idea?
Because everyone’s financial situation is unique, it’s important to carefully consider the benefits of debt consolidation before making a decision. There are some situations, for example, where it may not be worth it—like when you only have a short time remaining to repay your debts. But in other circumstances, it could be worth your while.
It May Help You Save Money
If you have several high-interest debts—like credit cards, store cards, or pawn shop loans—you may be able to save money on interest by consolidating them. In some cases, you might also be able to save money on fees. Some of the fees you could encounter with your current debts include:
- Annual fees
- Cash advance fees
- Late payment fees
- Over-the-limit fees
- Balance transfer fees
- Returned payment fees
- Foreign transaction fees
You Can Simplify Your Finances
If you have multiple debts that you’re repaying, you’ll have several different due dates to remember each month. The more you have, the greater the possibility of accidentally missing a payment. If this happens, it could damage your credit score. You may also be hit with an expensive late payment.
By consolidating your debt, you’ll only have one payment to keep up with each month. This greatly simplifies your finances and helps with budgeting.
It May Help You Pay Off Your Debt Faster
Debt consolidation may help you pay your debts off faster if you’re currently making the minimum monthly payments but you’re having trouble keeping up with everything. If interest rates are high, these small payments may not make much of a dent in your remaining balance.
This causes some people to get trapped in cycles of debt that are difficult to break free from. It’s also possible for your balance to grow due to the high interest rates from a substantial balance, plus you also have to deal with costly annual fees or late fees.
By having a fixed repayment schedule with a debt consolidation loan, the payments you make will steadily decrease the loan principal. Every payment you make will bring you closer to paying off your debts.
You Can Lower Your Monthly Payments
If you’re currently struggling to make your monthly payments, debt consolidation can also be used to lower them. This is typically done by increasing the time it takes to repay your new debt consolidation loan. The longer it takes to repay your loan, the lower your monthly payments will be.
However, an important negative to consider with this strategy is that you’ll pay more in interest with a longer loan term. That said, this might be better if you’ve been missing payments and it’s affecting your credit score.
It May Help Your Credit Score
Credit scores are now used for more than just obtaining loans. For example, your credit may be checked when you apply for a job or rent an apartment. Because your credit score is so important, you should closely monitor it to make sure it remains strong.
An important way that consolidating your debt can help your credit score is by lowering the available credit that’s currently available to you. This is known as your credit utilization ratio, and it’s one of several factors that contribute to your credit score.
Using a high percentage of your available credit could harm your credit score. Ideally, you want to use less than 30% at any given time. Less is better, in this case.
If you consolidate your credit or store card debt, you would transfer that balance to a debt consolidation loan. Because loan debt isn’t a factor in your credit utilization ratio, it will immediately lower the amount of available credit you’re using, which ultimately will help your credit score.
Debt Consolidation Loan Options
If you’re considering a debt consolidation loan, another option to explore is to go through a non-profit credit counseling agency, like San Francisco Federal Credit Union’s partner, BALANCE.
If you partner with an organization like BALANCE, a credit counselor will work closely with you to develop a plan to pay off your unsecured debts. Your counselor will also work with your creditors to negotiate lower interest rates and potentially have fees waived.
Read about debt consolidation loan options now: