Debt consolidation, also known as credit consolidation, is a way of merging multiple debts into a single loan with lower interest. It is often done when you have multiple unsecured high interest debts, such as a personal loan or credit card bills. Consolidating your debt reduces your monthly payments, in part, by increasing the repayment time. It can help make your debt more organized and manageable.
A significant debt can be overwhelming. When you drown, debt consolidation may seem like a lifesaver. In many cases it can be useful, but there are factors that require consideration first. Get information about what you do and what you don't do, and what the inconveniences are before making a decision.
How does debt consolidation work?
To consolidate your debt, you usually get a consolidation loan from a bank or other lender that will merge your other debts.
Here is an example of what the consolidated debt would look like:
How does debt consolidation affect your credit score?
Debt consolidation can have positive or negative effects on your credit score depending on how you handle it. These are some of the ways that can affect your score:
- Paying on time. Reduced monthly payments on a consolidated loan can make it easier for you to make your payments on time, which will help your credit score.
- Create a credit query. Too many inquiries can reduce some points of your credit score. It could also lead lenders to believe that you depend too much on borrowed funds.
- Lose account history. Payment and credit duration represent 50 percent of your total credit score. Closing these accounts means losing a valuable track record that can negatively affect your score.
- Opening of a new line of credit. If your credit reports are full of debts in addition to the accounts that are being consolidated, adding another to the combination could cost you. Too many lines of credit at the same time can cause a drop in credit rating.
- Total cost over time. A consolidated loan means lower monthly payments but more money spent over time. If you can meet your individual payments, it might be worth saving the money.
- Terms of the consolidation loan. The interest rate for your consolidated loan must be lower than your other loans. If you don't think you can make payments with consolidated terms, it probably isn't worth it.
- The right lender. Do your research long before choosing a place to consolidate. Some lenders may have attractive offers but worse terms in general. Remember, lenders are not impartial and, ultimately, want to earn money.
- Duration of the loans. If you have almost finished paying a loan, it is better to finish repaying it instead of making it a longer payment.
- Habits of money. Consolidating your debts will not solve the money habits that could have caused problems to start.
- Affordable payments If you cannot pay the consolidated payment, you can consider debt settlement or bankruptcy.
Pros and cons of consolidating debts
The biggest benefit to consolidate the debt of many people is the lowest monthly payment. This reduces the financial burden and can make it easier to make payments on time, eventually pay off all debt and reduce the debt / income ratio after it has been paid. It can also facilitate the reservation of money for an emergency instead of allocating it to payments. Consolidating multiple debts into a single debt can make debt tracking easier to manage, since there is only one account to follow.
While there are many advantages to debt consolidation, it is also important to consider the disadvantages. Some of the main disadvantages include:
- Paying more in interest. In addition to lower interest rates, consolidation loans often come with longer repayment terms. Although you may be paying less each month, the years added to the life of your loan will probably force you to pay more in general.
- Lose your house The unpaid credit card debt is subject to charges; An unpaid home equity loan is subject to foreclosure. Think carefully about your financial situation before risking your home.
- Download options. If consolidation is the last resort before bankruptcy, think twice. You may not be able to cancel a consolidation loan in the same way as consumer credit, leaving you with even less financial protection.
- Accumulating more debt. Some consumers make the mistake of paying their cards with a home equity loan only to recover those balances at some later time. Do not consolidate your revolving credit debts in this way unless you are committed to changing your spending habits.
Debt consolidation can help lift the burden of high monthly payments, but it carries many other risks. It is not a decision that should be taken lightly. Take the time to make sure it's worth it in your specific circumstances. It is also important to commit to improve financial habits and repair credit.