8 Must-Know Debt Consolidation Facts
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If you are feeling overwhelmed by your debts, you may have considered debt consolidation. By consolidating multiple credit card or loan debts into a new account with a single payment, usually at a lower interest rate, you may find yourself in a better position to start digging your way out. After all, managing multiple overdue accounts can become awfully stressful.
Before going down that road, it’s important to understand what you’re agreeing to. Here are eight debt consolidation facts that could help you determine whether debt consolidation is right for you.
1. Debt consolidation doesn’t erase your debt
It’s important to understand that while a debt consolidation loan can make paying down your debts easier, and possibly reduce your overall interest rate, it does nothing to reduce the amount of your debt. Make sure that you can handle the payments on the new loan, and that it will truly help you pay down your debts faster and more efficiently.
2. You will be working with a new lender when you consolidate
When you obtain a debt consolidation loan, this generally means that you are working with a new lender. This isn’t good or bad, but it will require that you understand the terms of the loan and any rules unique to this lender.
3. Debt consolidation loans can be secured or unsecured
Some debt consolidation loans are secured by collateral that you provide. Collateral can be things like your home, land or an interest in a business. Secured loans might be easier to qualify for and might also carry a lower interest rate than unsecured loans. The risk is that if you default on the loan, the lender can take the collateral.
Unsecured loans reduce the risk of losing collateral but may be harder to qualify for if your credit isn’t good. The interest rate on an unsecured loan will likely be higher, so be sure that the benefits of consolidating still make sense for you when paired with a high interest rate.
4. Personal and home-equity loans can be used for debt consolidation
Because personal loans generally come with a fixed interest rate, they can be an attractive option for consolidating multiple fixed-interest loans. This allows you to pay off your debt with the knowledge that your rate and your payment will stay the same. However, personal loans sometimes require collateral, which you could lose if you default.
The same is true of home equity loans. And the interest rate on such a loan may be even lower because your home serves as the collateral. Before going either route, be sure that you can afford the payments.
5. Debt consolidation loans may involve fees
Various forms of debt consolidation loans may come with upfront fees that raise the overall cost of the loan. For example, a home equity loan might include fees for the lender to appraise the value of the property or closing costs for the loan. A personal loan might include an origination fee that increases the APR for the lender.
Be sure that you ask about any and all fees and expenses over and above the interest rate on the loan so that you can evaluate the total cost and decide if this is a good deal for you.
6. Balance transfers might be an option for debt consolidation
Credit card companies sometimes try to attract new members by offering good deals on balance transfers. For a limited time, they may invite you to transfer your balance from other cards with a period of low or zero interest. This can be a good option for consolidating higher-interest credit card debt.
But remember, this is still a credit card that needs to be paid on time. And at some point, the interest rate will revert to a higher one, increasing the amount of interest (and decreasing the amount of principal) you are paying each month.
If you go this route, be careful to diligently pay off as much as possible under the promotional rate to take full advantage of the offer.
7. Your credit will influence your options for debt consolidation
As with any type of loan, a better credit score will open up more debt consolidation loan options for you. Better credit will help you get a better interest rate, as well.
If your credit is fair or bad, you might still qualify for debt consolidation, but it will likely cost you more and may require you to go with a secured loan. Under these circumstances, you will want to evaluate if the cost of the loan still makes debt consolidation the best option for you.
8. Debt consolidation may not be your best option
Kudos for wanting to pay off your debts. Just remember that debt consolidation is not the best option for everyone. If your balance is relatively small, you might be better off just tightening your belt and paying off the accounts you have. Other types of debt, like auto or student loans, might be better candidates for refinancing.
If the cost of a debt consolidation loan drives up your payments or the overall cost of the loan, you probably want to look elsewhere.
The bottom line
When your debts start to feel unmanageable, it makes sense to consider a debt consolidation loan. But like any financial decision, you need to read the fine print to be sure you’re making the right move. Whichever path you choose, getting out of debt requires time, dedication and discipline. And the benefits should outweigh the costs.