If you are burdened with too much debt, you have probably considered consolidation. While it is often billed as a stress-free solution to your problems, banks and consolidation companies don’t offer their services for altruistic reasons: the motivation is profit. So, when is debt consolidation worth it? Read on to learn a few do’s and don’ts.
Let’s start with the negatives first. When it comes to debt consolidation;
- Prioritize simplicity. It’s easy to become overwhelmed by too many balances, interest rates and due dates, but that doesn’t mean consolidation will make things easier in the long run. Sure, one payment is less burdensome on paper, but the wrong deal could lead to a higher interest rate and more money paid over time. Prioritize savings over the feeling of simplicity. There are better ways to streamline your life.
- Rely on a single opinion. Debt consolidation companies are bound by law to provide terms and conditions before refinancing your balances, but they are also in business to sell their services. You will likely hear the phrases, “Peace of mind,” “Take the stress away,” etc. It’s important to remember that the primary goal of these sales tactics is not your financial health; gaining your business is Priority #1. Consult impartial third-parties before making a financial decision. A credit repair professional and financial planner will shed light on the situation.
- Crunch the numbers. As we’ve said, there are better ways to streamline your life, and they begin with simple math. It doesn’t take an economics degree to determine whether debt consolidation is the right choice. The Web is full of free calculators to help you make an informed decision. For example, FinAid.org provides a consolidation calculator for students, but there are ways to use it for other debt types as well. Suppose you have a $25,000 personal loan, a $5,000 federal student loan, and a $15,000 private student loan. At their current interest rates, it would take 10 years and cost approximately $57,724.22 to eliminate your debt. Consolidating your debt at a fixed interest rate of 5.25% may be simple, but the same 10 year term would actually cost about $200 more in interest payments. Further, extending your payment term could add thousands to the bottom line.
Consider all the mathematical factors and consult your financial planner along the way. A few calculations will help you gain control of the situation.
- Consider the effects on your credit and future plans. Consolidating your debts has the power to positively affect your credit if it saves you money, but it could also cause a few setbacks, including:
- Creating a credit inquiry. While one or two inquiries aren’t likely to damage your credit score, too many could shave a few points off your credit score. It could also lead lenders to believe that you rely too heavily on borrowed funds.
- Closing old accounts. The benefit of the old accounts is twofold: payment and credit length, which account for 50 percent of your total credit score. Closing these accounts means losing valuable history that may negatively affect your score. This is especially concerning if you plan to buy a home, car, of finance another major purchase in the near future.
- Opening a new line of credit. If your credit reports are stacked with debt in addition to the accounts being consolidated, adding another to the mix could cost you. High-risk borrowers are known for carrying too many lines of credit at once, often resulting in a credit score drop to illustrate the behavior. Talk to a credit professional about how a new account may affect your credit status and whether now is the right time for consolidation.