What Is Debt Consolidation (And Should You Do It)?
Personal debt management is a key financial skill that allows consumers all over the world to achieve long-term, short-term and even daily financial goals.
However, personal debts can easily become challenging to manage throughout the borrower's lifetime. The loss of a job, the growth of a family and high-interest rates are all contributors to the heavy burden that debt can place on both budgets and bank accounts.
To abate their risks and lower their monthly costs, many consumers have turned to the process of debt consolidation in recent years.
What Is Debt Consolidation?
Debt consolidation is the process of combining certain types of personal debt into a single monthly bill with a low-interest rate.
This is normally done by taking out a loan that is used to pay down or eliminate your current debts. However, this does not mean that your debt is gone for good. Your consolidated loan will have a term length, principal, and interest payments that are expected to be paid off within a certain period.
Debt consolidation programs exist for many unique types of debt, including:
- Student Loans
- Credit Cards
- Medical Bills
- Payday Loans
Several other types of debt can be consolidated through loans, programs and debt relief solutions. It is important to familiarize yourself with the options available to you through your location, company benefits or personal financial situation.
Reduced payments and convenient monthly bills make this method of debt repayment one of the simplest processes to both start and finish. However, consumers should be aware that there is a significant difference between the function of debt consolidation versus the actions of a debt settlement.
What Is The Difference Between Debt Settlement and Debt Consolidation?
Contrary to popular belief, debt consolidation does not use the same processes as debt settlement cases. In fact, there are significant differences between both.
- Debt consolidation is the process of combining all debts into a single, lower payment. In contrast, debt settlement is a legal process used to settle outstanding debts with high balances that the borrower cannot repay.
- Settlements are often initiated through specific companies or specialized industries that have training in negotiating lump sum payments for lenders. On the other hand, debt consolidation is often performed through your local credit union or lending agency.
- Debt settlements are lengthy, taking two to three years on average to finalize. Debt consolidation is a straightforward task that requires a much shorter amount of time to approve and complete.
While both debt settlement and debt consolidation programs serve as a pathway to financial freedom, the risks and challenges associated with each vary considerably.
What Does Debt Consolidation Help With?
When used correctly, debt consolidation assists borrowers in several ways. Proper debt consolidation may:
- Substantially reduce your debt interest rates
- Speed up the repayment process
- Raise or firm up your credit score
- Lower your original debt amount (in some cases)
- Allow personal wealth to grow and thrive
Apart from finances, debt consolidation can be an excellent boost to the mental and emotional state of borrowers as well. Knowing that your financial future is secure and not at risk due to high-interest rates or unmanageable monthly bills is a great way to regain your grip on personal debts of all types.
However, debt consolidation is not a process that is right for everyone.
Factors To Consider Before Consolidating Debt
If used incorrectly or prematurely, debt consolidation can prove to be far more harmful than helpful.
There are three primary factors to consider before beginning the process of consolidating personal debts.
Know how much debt you need to repay. Debts that account for over 40% of your gross income are often incompatible with consolidations due to the resulting high-interest rates. Mortgages should not be included in this calculation.
After all other factors, consider the amount of debt you currently owe. This number can be determined by calculating your debts with their current interest rates. Be aware that consolidating all debts under a single interest rate may not necessarily give you a lower total than what you already owe.
If you are planning to consolidate personal debt, you most likely have a vision of what your future will look like. Planning to take on more debt after or during consolidation could pose huge financial risks and dramatically affect your credit scores.
Should You Consolidate Your Debts?
The question of whether or not you should consolidate your debt requires careful planning and thought before reaching an answer. While there is no golden formula or algorithm that can calculate success, borrowers should weigh each of the following factors before coming to a conclusion of their own.
- Is The Debt You Own Substantial Enough? Do your total debts (minus any mortgages) account for less than 40% of your total gross income?
- Can You Guarantee A Lower Rate? Are you aware of or looking into a program that will offer you interest rates that are lower than what you already owe?
- Are You Prepared To Make Serious Lifestyle Changes? Can you affirm that your household will not take on additional debts similar to these in the future?
If you can answer each of the above questions with a ‘yes,’ the process of debt consolidation is more than likely right for you.
Understanding What Is Debt Consolidation & Determining If It’s Right For You
Many factors go into deciding to consolidate debt, especially when considering other personal finance strategies. Borrowers are advised to be cautious while making your decision and talk to one of the credit union’s financial representatives or advisors.
If done correctly, the process of debt consolidation can be one of the most rewarding and enriching financial decisions a borrower will ever make.
Ready to embark on a life change you deserve?