Do you have multiple loans, credit cards, and debt accounts? Managing all these different debts and the interest rates attached to them can become overwhelming. All it takes is one missed monthly payment on any of these debts for you to receive a negative mark on your credit report.
A debt consolidation loan is the solution to this problem. It is a loan that pays off the account balances of all your other loans and credit cards so that you only have one loan to manage. So, instead of making several different monthly payments to various creditors, you only need to make one monthly payment to one creditor.
Is a debt consolidation loan right for you? Let’s review when it makes sense and doesn’t make sense to apply for a debt consolidation loan to pay off your debts.
When It Makes Sense
1. One Low Interest Rate
Multiple credit cards and loans with high interest rates can put you into even more outstanding debt. It makes sense to apply for a debt consolidation loan to eliminate all these high-interest payments and replace them with one low-interest payment. The debt consolidation loan will pay off the debts and consolidate them into one larger debt balance with a lower interest rate.
A lower interest rate means you won’t accrue as much debt as you work to pay off the loan balance.
2. One Monthly Payment
It is easier to manage one monthly payment than several payments to different creditors. A debt consolidation loan can reduce your monthly payments to one, increasing your likelihood of making your payment on time each month.
Making on-time payments is the key to building up your credit score and budgeting your finances more efficiently.
3. Increase Your Cash Flow
Do you live on a tight budget? One monthly debt payment will increase your available cash flow because you won’t need multiple payments. You can use the extra money from your available cash flow to cover your daily living expenses.
If any money is left over, you could save it for an emergency fund or invest it in a retirement fund. That would allow you to build wealth with your additional cash flow instead of losing wealth from all the interest payments.
When It Doesn’t Make Sense
1. Potentially Higher Interest Rates
Do you currently have a bad credit score? As much as a consolidation loan would help you build your credit score back up, you could face a problem regarding the interest rates.
Lenders still might be willing to approve your debt consolidation loan, but it would come with a high interest rate if you have a low credit score. Sometimes, the interest rate could be even higher than what you pay on your existing credit cards and loans.
2. Lengthy Repayment Term
A debt consolidation loan will be the equivalent of all your existing debts, forming a loan bigger than any others. You should expect a lengthy repayment term with your debt consolidation loan to cover the cost of paying back all that debt in monthly installments.
Some people don’t like having a long-term debt burden like this one. A debt consolidation loan may be wrong if you would rather juggle multiple debt payments with shorter terms.
3. Risking Your Assets as Collateral
Are you ready to risk your home, car, or other valuable assets as collateral for a debt consolidation loan? It is rare for a lender to approve an unsecured debt consolidation loan unless the applicant has excellent credit. Otherwise, the lender will require the applicant to put up something of value as collateral to secure the loan.
Suppose you don’t have any valuable assets or wish not to put them up as collateral. You won’t want to agree to a secured debt consolidation loan in that case.
4. Could Risk Accruing More Debt
Remember what got you into debt in the first place. The chances are that you were careless with your credit cards and loans by spending more than you could afford. The last thing you want to do is accrue a new credit card or loan debt after receiving the debt consolidation loan. That would make your debt problems much worse.
Getting a debt consolidation loan doesn’t make sense if you will get into debt again. Ensure you have learned your lesson by staying responsible with your finances and avoiding all other debt until the consolidation loan is paid off.
Alternative Debt Payback Strategies
A debt consolidation loan is a suitable choice if you get a low interest rate and the financial discipline to avoid more debt. However, if these things are impossible, you must find alternative ways to repay your debts.
Some effective debt payback strategies include:
Negotiate with the Creditors
Many creditors are reasonable when it comes to negotiations about debt payments. After all, they would rather you pay off your debts than default because they would get their money back plus interest. Defaulting on your loans means the creditors would not get their money back, which they don’t want to happen.
Try negotiating new monthly payment terms and interest rates with your creditors. They may help you by revising your debt contract to include more reasonable repayment terms.
Consider the Snowball or Avalanche Repayment Strategies
Financial advisors and counselors often recommend two repayment strategies: the snowball and avalanche methods.
The snowball method involves paying off your smallest debt first and then the next smallest debt. This process continues until all your debts are paid. The avalanche method is similar but focuses on paying off the highest-interest debt first and then moving on to the next highest-interest debt.
Talk with a professional financial advisor or credit counselor for further advice.
