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How Debt Consolidation Loans Can Simplify Your Life

Carl Andrews

Financial Advisor

How Debt Consolidation Loans Can Simplify Your Life

If you’re struggling to repay your debts, a debt consolidation loan could make good financial sense. Repaying your debts is an essential part of living a healthy financial life. Applying for debt consolidation can help you repay outstanding bills and reduce your monthly payments.

A debt consolidation lender helps borrowers to consolidate many debts, including high-interest credit card, medical bill, or personal loan accounts. Instead of paying each lender each month, you make a single, fixed-rate monthly installment on the consolidation loan for a certain period of time. Most debt consolidation loans have a two – five-year term, according to the Time Magazine. The interest rate charged by the lender on a debt consolidation loan depends on your creditworthiness. In most cases, the loan interest rate doesn’t change over the debt consolidation loan term.

Debt Consolidation Loan Strategy

Applying for a debt consolidation loan can help you manage multiple payments. Taking out a loan can stretch the money you have each month a little further. Use a debt consolidation loan calculator to analyze your debts and overall cost of borrowing. The debt consolidation loan may cost less or more than your current bills. Ask the following questions to review any consolidation loan offer:

  • Will the lender’s fees substantially add to my borrowing cost or am I saving money with a lower APR?
  • Can I pay more than the lender’s fixed monthly payment to pay off the loan faster? Does the lender allow flexible payments?
  • Does the lender allow for a co-signer with better credit to reduce my consolidation loan interest rate?

Look for debt consolidation lenders that do not charge origination fees and/or allow you to apply with a co-signer. Calculate the average annual percentage rate (APR) on your outstanding debts to determine how much money you can save with a debt consolidation loan.

Becoming Debt Free

If you’re drowning in debt, every penny matters. For instance, John owes USD 25,000 on a dozen credit cards. The minimum payments needed to service the outstanding debt quickly cut into John’s ability to pay the mortgage and buy food. In John’s case, the decision to consolidate his credit card bills into a personal debt consolidation loan helped him to get debt-free.

After John used the debt consolidation loan to repay his credit cards, he simply focused on paying a single loan. He opted for a five-year fixed rate loan and locked in a lower APR on the total debt owed. His lender offered flexible payments, so John repaid the debt consolidation loan in just four years or 48 months.

A debt consolidation loan can help you become debt-free, but it's important to consider the following at the start.

Tip 1: Consider Borrowing Cost

Interest rates and the cost of money may be an obvious motivator to apply for a debt consolidation loan. It’s critical to reduce APRs on high-interest debt, such as credit cards or retail store cards, and reduce your interest rate.

Ideally, the debt consolidation loan eliminates a significant sum in future interest payments.

Tip 2: Simplify Payments and Improve Cash Flow

However, simplifying your payments is another important reason to consolidate debt. If you’ve got a dozen credit cards like John, it’s more challenging to know when each payment is due and how much is owed to each lender. Late payments and additional fees can result from confusion about payments, especially when credit lines are at or approaching maximum limits.

Consolidation of debts with a debt consolidation loan can make it easier to manage debt. Staying on top of multiple loans and/or debts can make it difficult to manage a declining monthly income. More income is required over time to pay monthly bills because interest applied and over-limit fees enter the picture.

Tip #3: Fixed Rates and Flexible Terms

When interest rates are at or near historical lows, it’s probably beneficial to lock-in a fixed rate on a debt consolidation loan. An open-ended credit line or bank facility can help the borrower rationalize there’s less immediate need to repay the loan.

In comparison, a fixed payment and loan term provides a certain goal. You’ll know the monthly payment, when the payment is due, and how many months to go before you’re debt-free.

A flexible loan can also simplify your life. Let’s say you receive a significant part of your annual income in a bonus each December. If your lender allows flexible repayments, you can make decisions to pay off the debt consolidation loan faster.

What should you do before consolidating your debts?

Consider your options

There is more than one way that you can consolidate your debt, some of which you can do on your own. Also, there are two kinds of debt: unsecured and secured. On your own, you can just take out a personal loan, or get a balance transfer to a credit card. Moreover, home equity line of credit and home equity loan can both be obtained to pay off your debts. What you would get, of course, depends on your situation, your assets, and the total amount you owe. Although there are many pathways to financial freedom, make sure that what you choose is the best and quickest way for you. Each person has a unique situation and this is why you need to be careful when choosing a debt consolidation strategy.

Decide what debts you want to consolidate

Categorize your debts into two piles: the ‘good’ debts and ‘bad’ debts. The good debts, ironically, are the high-interest accounts where you ideally owe large amounts as well. The bad debts, on the other hand, incur low interests and may or may not have a great amount which you owe. When a certain account does not fit exactly in the two categories, put it with the other good debts unless it incurs low interest or is far from being maxed out yet. Many make the mistake of consolidating all their debts just for the convenience, but you may be losing by doing so. For example, if you combine your low-rate student loan with your credit card debts, you miss out on the rate discounts and rebates. Plus, you also begin to be charged with a higher rate than the original. The point of consolidating your debt is to make the payments more manageable, but if you consolidate the bad debts, you will just make your life harder.

Choose the right professional

This industry is infamous for their shady tactics and practices. Lots are just waiting for you to fall into their traps so that they can squeeze as much money from you as possible. However, this does not mean you should not pursue your dream of being completely debt-free. This just means that you should know where to look for the right ones.

If you have already shortlisted companies you are considering, check their website and reviews. What do past and current customers say about them? More importantly, check with the Better Business Bureau before ultimately choosing which ones to contact. Companies that constantly bombard your inbox with junk mail should raise a red flag and be avoided at all cost. The same goes for those that offer deals that are just too good to be true. Chances are, they’d be a burden rather than a help.

For non-profit agencies, they should belong to the Financial Counseling Association of America or National Foundation for Credit Counseling so you would be sure that they maintain high standards and all their counselors have the necessary certifications. Lastly, do not be afraid to ask about success rates and fees once you have met with a financial counselor (which should be free, by the way).

When should you go for a debt consolidation loan?

You have multiple high-interest debts

One of the biggest benefits of a debt consolidation loan is that it lets the agency you have entrusted to do the payments on your behalf to negotiate a low-interest rate as well. Because of this, you get a better deal without moving a finger. Allocating a certain percentage of your monthly income to your loans is stressful when you barely have enough to survive the month. It becomes much worse when you feel that all your efforts are futile because the annual percentage rate is so high that what you are doing only helps in making sure that you do not owe more than you already do.

You are missing payments because you can’t keep up with the different deadlines

You already have too much on your hands as it is, so even when you have the cash to settle your monthly payments, you miss them. This can be deemed as only negligence on your part or straight up interpreted as lacking the financial capacity to pay, both of which are frowned upon by lenders. Moreover, this goes on your credit record, thus having some form of impact on your credit score. Because we are sure you definitely want to be a responsible borrower and do not want the interests to compound, you can get a debt consolidation loan to make your life simpler.

You meet the basic credit rating requirement

Debt consolidation loans are not for everyone. While this is a great way to simplify things, there still are requirements that you have to meet. One of these is a credit score of at least 640. If you are sure that this is the best way to go given your situation, make ways to raise your credit score if you fall a few points short of the credit rating requirement.

You want to regain control of your finances

Dealing with money will always be a mess, especially when you have kids or are supporting your parents. Juggling so many things and the payments that are eating your monthly pay away can be a thing of the past. You can gain control of your finances and of your life by consolidating your debts.

When should you NOT get a debt consolidation loan?

You are not willing to address the root cause

Consolidating your high-interest credit card debts is just a cure. That means that even after you have cleared yourself of debt after the program, you can fall into the same or even deeper hole again. Address the root cause of your debts: overspending. Come to terms with it. Being thrifty should not be practiced only when in the process of erasing your debts. It must not be a habit.

Your credit counselor will look at your finances and identify trends on where you spend most of your income. It could be anything from leisure or basic needs. Whatever it is, you would need to find ways to downgrade your lifestyle. Don’t gloss over your mistakes, but instead recognize them and correct them. Be ready to make sacrifices because that is the only way you would get out of the debt cycle forever.

You plan to continue using your credit cards

If you have a maxed-out credit card, it would feel like such a huge relief seeing freed up credit again. However, remember that you still owe that money. Those have not been paid yet. If you plan on using one of your cards just this one time, make sure that it really is just this one time. Make sure also that it is an emergency. Else, you may end up with your cards maxed out again. Cancel most of your cards or store them somewhere it would be hard for you to get. Just keep one or two with low credit limits for real emergencies.

You do not need it

Debt consolidation is not for everyone. So, how do you know that it is for you? Before diving into this decision, make sure that it is in your best interests. If the accounts you are paying and the amount you owe are still manageable, it might not be the time to consolidate your debts. While it is not advisable that you wait until you are in too deep already, it is not also recommended that you get it just because.

Carl Andrews

Carl has years of experience helping people tackle debt. As a Senior Financial Advisor, he knows the ins and outs of debt consolidation and debt management. He holds a Masters Degree in Finance and according to him, not all debt problems are the same and that’s why it’s important to take a look at the different options available for your situation.