What is debt consolidation?

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What is debt consolidation?

Debt consolidation is the process of taking out a new loan to pay off multiple outstanding debts. As personal loans tend to carry lower rates than credit cards, consolidating debt not only simplifies your various obligations with a single payment, but you will also likely pay less interest by qualifying for a lower rate.

How does debt consolidation work?

The process of consolidating debt is relatively straightforward. First, research the type of lender you would like to use and compare their rates and terms.

Once you identify which option is most suitable for your needs, fill out an application. Be sure to read all the paperwork before signing to avoid any surprises somewhere down the line.

After getting approved for the loan and receiving the funds, use this new loan to pay off your outstanding debts promptly. If you don’t, your current creditors may take legal action against you, which could result in additional unwanted fees.

Lastly, stay on top of your plan! Remember to make regular monthly payments on your new loan until it is paid off in full. Doing so could be your first step toward building wealth and could ensure your credit score improves or stays healthy in the future.

What are some of the potential pros and cons of debt consolidation?

Pros

Lower monthly payments
Paying less in interest
Simplified bill-paying
Easier to track progress
More likely to stick to a budget
Improved credit score over the long-run
Get out of debt faster!

Cons

Difficulty qualifying
Does not reduce the aggregate amount of capital owed
Rates may be higher for borrowers with poor credit
Potentially subject to additional fees
Your new loan may have a longer repayment period – this could impact the total amount of interest payable
Short-term credit score dip

How to get started with a debt consolidator?

Understand the Risks

As a first step, it’s essential to consider the risks associated with debt consolidation. Depending on the terms of your new loan, you could increase the interest you will pay over time or increase the length of time you make payments. It’s also essential to take into account the short-term impact debt consolidation could have on your credit score, as well as any fees that may be associated with the process. Do the math carefully before you consolidate your debt.

Check Your Credit Score

Your credit score will be a significant factor in determining not only your eligibility for a loan but also the interest rate that the lender will offer you.

Determine Loan Amount

How much money do you need to pay off your debts? Calculate this desired loan amount. It is crucial to make sure the size of your loan is large enough to pay off your high-interest debt; however, you may also have to consider any limits your lender puts in place on the amount you are allowed to borrow.

Shop Around

Now that you know your credit score, loan amount, and are educated on the risks of debt consolidation, it’s time to see what’s out there. Shop around for reputable lenders who offer the most competitive interest rates and terms that are right for you. In addition to the rate and repayment period, be sure to consider factors such as origination fees, annual fees, balance transfer fees, and closing cost. The goal is to make sure that all interest and fees relating to a new loan ass up to less than the interest amount of the debt you are looking to consolidate.

Get Pre-Qualified and Apply

The pre-qualification process involves submitting information such as income history and proof of identification. If approved for the loan, you should receive the funds requested directly into your bank account or a prepaid card, depending on lender policies.

How does my credit score impact my loan rate?

When a lender considers your loan application, your credit score will be important in determining your eligibility for a loan and the interest rate offered if approved. Generally, there is an inverse relationship between your credit score and the interest rate you are offered. Those with higher credit scores are seen as lower-risk borrowers and will likely be offered lower interest rates. Those with lower credit scores are seen as higher-risk borrowers and will likely need to accept higher interest rates. Ultimately, if your credit score is too low, debt consolidation might not be the best option for you.

How is my credit score impacted by consolidating debt?

When thinking about the impact debt consolidation will have on your credit score, you should consider both the short-term and long-term effects.

Short-Term

During the process of consolidating your debt, your credit score may dip slightly as creditors pull your credit report when applying for the loan. These hard inquiries appear on your credit report and could temporarily lower your score per inquiry.
Suppose you end up closing accounts or credit cards after paying off those debts. In that case, it may temporarily lower your score as it can reduce the length of your credit history. It also changes your credit utilization ratio, which will impact your score. Your credit utilization ratio measures the sum of your balances divided by the sum of your credit limits. In other words, credit utilization calculates the amount of credit you use relative to your credit limits. Using too much of the credit available to you can harm your score.

Long-Term

Once you’ve consolidated your debt, made payments on time, and kept your balances low on any open account, you’re likely to see your credit score increase. Your score will reflect your improved financial behavior as you work to become debt-free!

Are there fees associated with debt consolidation?

When considering taking out a loan to consolidate your debts, you must know what kind of fees you may face.

Example:
Origination Fees, usually a percentage of the total amount borrowed, are used to cover processing costs. Other fees may include annual fees on the loan and loan closing costs.

How do I stay on track with my debt consolidation plan?

• Be disciplined with your spending habits.
• Create a budget.
• Identify which bills can be reduced or eliminated.
• Set aside an emergency fund so unexpected circumstances don’t derail your progress!
• Seek help when you need it. There are countless resources available online and through credit counseling services that help people become debt-free.