Managing all your debts, with multiple due dates, interest rates, and minimum payment amounts, can be very difficult to keep track of. Missing a payment can hurt your credit score and your chances of borrowing money in the future.
That’s why consolidating all your monthly bills into one payment with a new personal debt consolidation loan can be a great way to simplify your financial life, keep your credit strong, and make it easier to pay off what you owe each month. . Of course, you should continue to pay all your bills on time until you have simplified the payment setup with your new loan.
How a Personal Debt Consolidation Loan Works
A personal loan is a debt product that can be used for almost anything. You will receive the funds in a lump sum and make monthly installments over a specified period. Additionally, personal loans are generally unsecured, which means that they are not backed by collateral and do not expose you to the risk of losing your asset.
Some consumers get personal loans and use the product only to consolidate their debts, which is why you will often hear the term “debt consolidation loan“. Using a personal loan to consolidate debt involves paying off all your credit cards, loans, and other debts with loan proceeds and making a manageable payment on your loan each month until it’s due. refunded.
To illustrate, suppose you have the following credit cards:
- Card 1 carries an APR of 15%, the minimum monthly payment is $25, and the outstanding balance is $500. (Payment term: 24 months; Total interest paid: $78)
- Card 2 carries an APR of 17%, the minimum monthly payment is $30, and the outstanding balance is $750. (Repayment term: 32 months; Total interest paid: $182)
- Card 3 carries an APR of 19%, the minimum monthly payment is $35, and the outstanding balance is $1,000. (Term of payment: 39 months; Total interest paid: $341)
If you take out a personal loan of $2,250 with a term of 36 months and an interest rate of 10%, your monthly payment will be $73, slightly less than what you are already paying. Plus, you’ll only pay $363.64 in interest over the term of the loan, a decrease of $237.36.
A personal loan can also help keep your accounts in good standing and maintain your credit rating if you have multiple types of debt. Being late on any of your payments, whether for a credit card or a student loan, can crush your credit score. It could also hamper your chances of borrowing money or getting competitive terms on debt products in the future.
Advantages of debt consolidation with a personal loan
Debt consolidation with a personal loan has several advantages that make it an attractive option:
- One monthly payment: It can be difficult to keep track of multiple monthly debt payments. A debt consolidation loan simplifies your finances and allows you to make a single monthly payment.
- Lower interest rates: Personal loans often come with higher rates than secured loans, but they can have lower rates than credit cards.
- Pay off your debts faster: With a lower interest rate, you may be able to save money and pay off your debt sooner with a personal loan.
- Improve your credit score: Using a personal loan to consolidate debt can improve your credit score by increasing your available credit, which lowers your credit utilization rate.
Disadvantages of debt consolidation with a personal loan
Although a debt consolidation loan has its advantages, there are also disadvantages that you should consider:
- Potentially high interest rates: Personal loans generally have lower interest rates than credit cards, but personal loan rates can exceed 30% for borrowers with poor credit.
- Additional upfront costs: When you take out a personal loan, you may be subject to loan origination fees. Other common charges may include prepayment penalties and late payment charges.
- Could encourage more spending: Debt consolidation does not solve the fundamental problem of why you got into debt. If you consolidate your credit card debt with a personal loan, you may be encouraged to take on new debt.
When to take out a personal loan for debt consolidation
High-interest debt, such as credit card debt, could make you a good candidate for a debt consolidation loan, as personal loans tend to have lower interest rates than cards. credit. You might be a good candidate for a personal loan if:
- You have strong credit: The better your credit, the more likely you are to qualify for a loan at the lowest interest rate. The lower your interest rate, the less you have to pay on top of the money you borrow.
- You have a large but controlled debt: If your debt is large but you can make at least minimum monthly payments, a personal loan might be best for you.
- Your expenses are under control: A personal loan will not help you if you do not control your expenses. This could put you in even more debt. Before getting a personal loan, review your finances to make sure you can afford the loan and pay off your debt.
When not to take out a personal loan for debt consolidation
Although a personal loan for debt consolidation can help you save money and get out of debt faster, it’s not always the best choice. Here are some cases where a loan would not be a good idea:
- Your credit rating is low: It is possible to qualify for a personal loan if you do not have good credit. Unfortunately, chances are you’ll only be entitled to high interest rates, which could make the costs of consolidation outweigh the benefits.
- You are not eligible for lower interest rates: If the personal loan rates available to you are higher than what you are currently paying on your debt, try other methods of settling your debt. Once your credit improves, you may qualify for debt consolidation loans with better terms.
- You have trouble affording your minimum monthly payments: You could get a more affordable monthly payment by consolidating. However, if money is already tight and you are living check after check, you may find it difficult to make timely payments on a personal loan. So consider crunching the numbers before you apply to determine if it makes sense to take out a debt consolidation loan or if it’s better to ask your lenders or creditors to enroll in a hardship program (if applicable).
Other Ways to Consolidate Debt
If a personal debt consolidation loan isn’t right for you, there are several ways to consolidate your debts.
Home Equity Loan
If you own your home and your mortgage debt is less than the value of the home, you may be able to take out a home equity loan and use it to pay off your outstanding debt. A home equity loan is a type of second mortgage that lets you borrow against the equity in your home. You can use the lump sum you receive from your home equity loan to pay off all your outstanding debts, then make a single payment on the new loan each month.
For home equity loans, your home is secured. As a result, the lender views your loan as less risky, which means interest rates are generally lower than unsecured loans such as personal loans. However, you could lose your home if you fall behind or fail to pay off your home equity loan. Calculate the equity in your home to see if you would qualify to borrow enough to cover your outstanding debt.
Credit cards with balance transfer
You can try a balance transfer credit card if you want to manage a few credit card balances. Many cards offer 0% APR for a fixed term, usually 12-21 months.
It’s a great way to transfer all of your existing credit card debt into one manageable monthly payment. Remember that if you have a lot of credit card debt, you might not be approved for a balance transfer for the full amount you need. This means you could pay off your new card balance and any cards that couldn’t be transferred.
If you don’t pay a balance transfer credit card before the end of the 0% APR period, the card issuer starts charging interest.
Debt repayment strategies
You may need to manage your debt differently if you don’t qualify for a new loan or credit card transfer. If you haven’t already, start by organizing your debt on a spreadsheet. Write down each lender you owe money to, your current interest rate, the amount you owe, and your monthly due date. From there, you can try a few debt management methods:
- Debt Snowball: This method focuses on paying off your smallest debt first. While making minimum payments on all other debt, you put all your extra money on the debt with the lowest balance. Once that’s paid off, you focus on allocating all of your extra money to the lower balance. Do this until all your debts are paid in full. The advantage is that you will see results quickly. The downside is that you might pay more interest on other higher-rate debt.
- Avalanche of debt: This method focuses on paying off the debt with the highest interest rate first. You make minimum payments on all your other debts, then put all your extra money on the debt with the highest interest rate. Do this until the debt is paid off, then move on to the debt with the highest interest rate until all of your debt is fully paid off. Although you can save more money by paying off the higher interest debt first, you might not see results as quickly as with the debt snowball method.
The bottom line
A personal loan could be a great way to consolidate your debt, but it’s not necessarily the right method for everyone. Examine your debt situation and see if a personal loan would work better. Otherwise, try methods such as a home equity loan or a balance transfer or debt management strategy.