It’s an indisputable fact: life is expensive. When the volume of bills and monthly payments threaten your day-to-day life, balancing your finances can be difficult. As a result, credit repair often takes a backseat to making ends meet. When you feel yourself drowning, debt consolidation may be the solution you’ve been searching for.
What is Debt Consolidation?
The act of debt consolidation is simple. Rather than paying off several loans with varying interest rates, the balances are lumped together into a single loan with a lower or fixed interest rate. Many lenders offer both unsecured personal loans and asset-based secured loans. The most common collateral for the latter choice is a borrower’s home equity. For example, the Larkins currently have $45,000 of unsecured credit card debt. Although they are able to make the minimum monthly payments, the variable interest rates on each of their five credit cards makes it difficult to aggressively pay down debt. As a solution, they decide to use their home as collateral to secure a $45,000 loan with a fixed interest rate. The home equity loan allows them to pay off the credit card companies and focus solely on one loan.
Regardless of the loan type, the goal is the same: one loan, one payment.
In addition to securing a single loan in lieu of many, the benefits of debt consolidation include:
- Higher credit scores that almost always result from lowered credit card balances
- A lower or fixed interest rate, allowing you to pay less each month
- The ability to pay down debt aggressively and focus on credit repair
- Forgoing the hassle of scheduling multiple payments each month
- Avoidance of multiple late fees and bad credit consequences that come with continued missed payments
- Possible tax breaks on loan interest (if you decide to use your home equity or secure a second mortgage)
- The ability to save money in an emergency fund while also paying off debt
Although debt consolidation may seem like a lifesaver, consider the possible drawbacks before jumping in. Consolidation comes with many risks, including:
- Paying more over time. In addition to lower interest rates, consolidation loans often come with lengthened payment terms. Although you may be paying less each month, the years added to the life of your loan will likely force you to pay more overall.
- Plateaued interest rates. The goal of consolidation is to pay less each month and secure a lower interest rate. Unfortunately, it may be difficult to find a rate that solves all your financial troubles. Unless your current debt is attached to very high interest, it may be wise to skip consolidation.
- Losing your home. Secured loans are sometimes preferable to unsecured consolidation, but in order to make sure this option is a good one, guaranteed repayment is a must. Unpaid credit card debt is subject to collections; an unpaid home equity loan is subject to foreclosure. Think carefully about your financial situation before putting your home on the line.
- Discharge options. If consolidation is the last resort before bankruptcy, think twice. It may not be possible to discharge a consolidation loan in the same way as consumer credit, leaving you with even less financial protection.
- Accumulating more debt. Some consumers make the mistake of paying off their cards with a home equity loan only to run those card balances back up at some point later. Don’t consolidate your revolving credit debts in this way unless you are committed to changing your spending habits.
The decision to seek debt consolidation is never easy. Making the right choice requires you to take a deeper look into your motivations and mathematical truths. Are you committed to credit repair, or are you worried about relapsing into credit card debt? How does consolidation compare with the overall cost of paying each loan individually? Answering these questions is the first step toward a more organized financial future.