Benefits of Debt Consolidation Loans
Although debt consolidation loans have been around for a long time, they have morphed into something unique with several key benefits. If you struggle to meet your financial obligations each month, consider consolidating all your outstanding debt instead of filing for bankruptcy.
Even with a stabilized economy, millions of people still face financial difficulties. While well intended, they end up “robbing Peter to pay Paul” just to keep their heads above water. Very quickly, the game of juggling debt becomes difficult to play, causing significant frustration and stress. If you find yourself in this situation, debt consolidation may be the right solution.
Types of Debt Consolidation
There are four types of debt consolidation. While they work in similar ways, they have distinct differences.
Credit Card Transfer
The most common type of debt consolidation consists of taking all outstanding credit card bills and lumping them into a payment on one card. This can help you take control of your finances, especially if you pay extremely high interest rates and struggle to make the minimum payments.
In this case, you would need to have good enough credit to qualify for a credit card with a high limit and the ability to transfer other balances over. With a credit card transfer, the issuer offers an introductory period during which time you pay 0 percent interest. If you decide to go this route, make sure you understand two things: when the introductory period ends and what the interest rate jumps to afterward.
The goal with a credit card transfer is to pay off the majority, if not all, of the outstanding balance within the introductory period. That way, every dime you send in goes toward the principal amount as opposed to the interest. While a credit card transfer makes sense in many situations, there is one risk worth noting: Carrying too much debt on one card can negatively impact your FICO score.
Some people take out a personal loan as a way of consolidating debt. Just like other types of loans, you would have an interest rate, a scheduled payment date, and a specific payment amount due each month. As this is an unsecured loan, meaning you use nothing as collateral, you need to have excellent credit.
The nice thing about a personal loan is you can use the funds for a variety of things, such as home improvement projects, vacations, and catching up on bills. If you have less-than-perfect credit, some lenders will still approve a personal loan. They will require either collateral, a higher interest rate, or a co-signer.
With a home equity loan, you use the equity in the house you own as collateral. Typically, you need to have good credit, and the amount of equity would need to meet the lender’s criteria. The advantage is you end up with a loan that has a lower interest rate so you can catch up on payments. In most cases, experts do not recommend a home equity loan unless you are facing possible foreclosure.
Debt Consolidation Loan
In the more traditional sense, a debt consolidation loan helps people with imperfect credit who desperately need to pay outstanding bills. This type of loan comes from different lenders, including banks, credit unions, and companies that specialize in nothing but debt consolidation.
The entire purpose of a debt consolidation loan is to combine all debt, thereby reducing your monthly financial burden. Since these loans vary from one lender to another, make your selection carefully. The benefit is that in most cases, the interest rate is significantly lower than what you currently pay. However, with a longer repayment term, you could end up paying a lot more than if you had just focused on the other bills.
Since the money from a debt consolidation loan pays off all your outstanding debt, you have just one payment each month as opposed to several. Not only is this loan a great way to manage your finances, but it also could allow you to put money into a savings account.
Depending on the lender or company you do business with, you may need to complete a course on money management. The reason is a lot of people overspend or become complacent about paying bills, resulting in a financial mess. The purpose of the course is to help people understand what behavior got them into trouble in the first place, so they do not repeat their mistake.
How a Debt Consolidation Loan Works
Regardless of the type of debt consolidation solution you choose, excluding a credit card transfer, the lender gives you a check with which you pay off debts. You can then focus on making one payment each month in the amount due according to the agreed-upon schedule.
However, because a debt consolidation loan is one of the top solutions, it is important to gain as much information beforehand as possible. That way, you can stay on top of your finances and slowly improve your credit score.
Typically, the best candidate for a debt consolidation loan is someone with relatively good credit who experienced an isolated incident of falling behind on bills. If you meet these criteria, this type of loan is highly beneficial. However, you must also determine the problem that started your financial troubles and come up with a plan to avoid repeating your mistake. Then, you can begin researching different lenders.
As an example, start by determining if you overspend, fail to follow a budget, or are a compulsive shopper. As long as you correct your behavior and genuinely want to improve your situation, a debt consolidation loan is an excellent choice.
Usually, people use a debt consolidation loan to pay off high-interest credit cards. However, you can use the money for other purposes, including:
Bills in Collection
When applying for a personal loan or debt consolidation loan, the lender will conduct a credit check. Because of that, you want to avoid making any purchases 60 days prior to sending in your application. At the same time, avoid applying for any new credit cards since multiple inquiries can damage your credit score and your chance of a lender approving your loan.
Always read the fine print before you agree to anything. The last thing you want is to dig yourself into a deeper hole by missing an important statement or clause. You want a means of solving your financial problem, not making your debt worse.
As long as you know your financial weaknesses and address them, there is an excellent chance that a conventional debt consolidation loan is what you need. With one payment each month, you should have no problem meeting the demand. In fact, if the payment is low enough, you might consider increasing it, perhaps doubling it.
Once you identify the reason you need financial help, search for a lender that offers loans with excellent terms and low interest. You can learn more about debt consolidation and other loans from our guide.