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4 Things to Know About Debt Consolidation

People around the world are making resolutions for the new year, and if one of yours is to pay down debt, then consider consolidating your credit card debt and/or other unsecured debt, especially if they have high interest rates.

Debt consolidation is essentially replacing several smaller loans or debts with a larger one. It combines your debts so you pay one monthly payment to a single creditor rather than multiple payments to different accounts with different interest rates. Ideally, debt consolidation reduces how much you pay creditors overall by reducing the amount of interest you pay.

This is not a one-size-fits-all option. Debt consolidation tends to be a better and easier option if you have a good credit score and room in your budget to make the necessary payments without increasing debt. If you do not have a good credit score and you are struggling to make your minimum payments, perhaps debt management would be a better option.

Before you do anything with your debt, here are 4 good things to know about debt consolidation:

1.  You’ve got options.

The two main options are debt consolidation loans and 0% credit card balance transfer offers. Each option has advantages and disadvantages.  What would be most beneficial to you depends on the amount you want to consolidate, the interest rate, and term of the loan (or term of the promotional interest rate).

A debt consolidation loan may be a better option if you need longer to pay the debt off. There are a number of options for debt consolidation loans. You could choose between a personal loan, a secured loan (like a home equity loan or other loan with collateral) or a retirement plan loan. Make sure you know exactly what fees, interest rates and payment terms would apply to each option so you make an informed decision.

A 0% credit card balance transfer offer could be a great option if you are able to pay off the entire balance during the promotional interest rate term (usually 12-18 months). Keep in mind that although the interest rate is 0%, there typically is a transfer fee of around 3% of the balance transferred.

2.  Consolidating your debt should simplify and reduce your payments.

To make debt consolidation worth it, the option you choose should reduce the total amount you pay because of a reduced interest rate.

You need a plan to pay off the consolidated debt and the discipline to stick to your budget. Debt consolidation will only benefit you if it reduces your monthly payments, enabling you to pay off that debt.

If you are not able to pay off your consolidated debt within the term of the loan or the term of the promotional interest rate, you might erase the gains you made by consolidating. So have a game plan for paying it off and stick to it!

3.  Debt consolidation could help you get out of debt quicker and manage your debt better

Debt consolidation could help you focus your debt repayment. But that is only as long as you are making payments that will pay off the debt within the loan term/promotional interest term, and not just making minimum payments.

As you make payments and reduce your debt, your credit score will gradually improve, even if it initially takes a hit by opening a new account or having a high credit utilization ratio.

4.  However, consolidated debt could also increase how much you pay overall—do the math!

Some lenders make money by offering you a lower interest rate for a longer loan term.  They end up charging you more total interest over the life of the loan, which will ultimately be more costly for you.

So do the math before making a decision. Calculate how much interest you are currently paying and how much you would pay over the life of the loan if you consolidate. Don’t pursue a debt consolidation option that does not reduce the total amount of your payments!

Make sure it’s right for you

What will work best for you really depends on your situation and the loans and offers available to you. If done right, debt consolidation can be a great option for managing and repaying your debt.  Stick to your plan and you could have greater peace of mind and future financial security.

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Kaycee Cuaira's picture

Kaycee Cuaira is a Texas-barred lawyer with an affinity for personal finance and planning. She has lived in Brazil, India, and Mozambique but prefers to live in places with four seasons.

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