Debt consolidation is a way to combine all of your credit card debt into a low-interest loan. There are a few reasons why people choose to consolidate their debt into one payment—it reduces the number of separate payments to keep track of each month and can lower the amount of interest you’re paying on high-interest credit cards.
While you will still have the same debt load right after you consolidate, the repayment terms are easier to manage since it will be rolled into one monthly payment. Debt consolidation can help you pay down your credit card debt quicker as long as you have a payoff plan and don’t rack up more debt.
Here’s what you need to know about getting all of your debt into one payment.
Should you consolidate your debt?
If you are dealing with high-interest credit cards and have multiple payments to make, debt consolidation may be best for you. The interest on credit cards are high, with the average rate in the U.S. being 14.65 percent. If you’re making minimum payments on your credit cards, you are also paying interest fees, which may add up over time and make the total cost of your debt higher.
If you are approved for a debt consolidation loan, your new loan will have a fixed payment amount and a repayment term, which helps provide a predictable schedule to pay off your debt. Having this end goal ahead is a great way to keep motivated.
Other loans to consolidate your debt
Home equity loans or cash-out home refinance: You can borrow against the equity in your home with a home equity loan or cash-out refinance. These often have low interest rates and high borrowing limits since the loan is secured by your home. Since the loan is secured by your home, you risk foreclosure if you fall behind on payments.
Cash-out auto refinance: Some lenders offer cash-out refinance auto loans that let you tap into the equity in your car. If you’re unable to make your payments, however, you risk losing your vehicle.
Retirement account loan: Many 401(k) plans give you the option to borrow up to 50 percent of your available funds, without going through a traditional loan application and credit check. You have five years to repay the loan plus interest, but this should only be considered as a last resort. It’s never a good idea to negatively impact your future retirement.
What are the pros of debt consolidation?
Getting out of debt quicker is probably the biggest advantage of debt consolidation. Once you pay off your debt, you can free up those funds you would’ve otherwise used to pay down your debt to start saving for a rainy day or investing for your retirement.
Another bonus is your credit score may improve after you pay off your debt.
What are the cons of debt consolidation?
The most important thing to note is that debt consolidation is not a way to transfer your debt into a loan and then make minimum payments. Sitting on your debt will extend the life of the loan, which means it could cost you more.
You’re using the loan as a tool to quickly get rid of your debt, which means you should anticipate making more than the minimum payments each month while avoiding further spending on credit cards.
When you first apply for the loan, you may notice your credit score go down. This is nothing to be alarmed about—it means the lender made a hard credit pull. Once you make regular, on-time payments, your score may go back up.
Watch out for loan origination fees, which are one-time added costs that you need to pay when you receive the loan. Some lenders add the origination fee to the balance. Origination fees may range from 1 to 10 percent of the loan amount. The origination fee may depend on your creditworthiness and term of the loan.
How do you go about consolidating loans?
If you’re ready to get rid of your debt for good and make positive changes in your spending habits, debt consolidation might be a smart option. Make sure to improve your credit score and shop around for the best rates from a trusted lender.