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Debt consolidation is the act of taking big loans (liabilities) such as credit cards, car loans, students loans and other liabilities and combining them into one new loan. The main purpose of debt consolidation is one of many long term strategies to help individuals get out of debt by helping to eliminate factors such as adding on more penalties to incorrect or late payments.
The terms of this loan depends on a few factors - including your credit history. Click Here to read about Credit Cards 101. However, the new loan that you use to consolidate all your debts will aim at setting terms to decrease what your monthly payments are. This makes it much easier to keep up with payments - as you will just have one to worry about instead of multiple payments due on different days of the month.
It is very important to note when reading this article that debt consolidation treats only the symptoms of the issue - it will not fix how you got there in the first place. This is behavior that you will need to change and work on your own. Consider your lifestyle and adjust accordingly. Create a budget to help track your spending and savings habits. For example, if you notice a lot of your money is being spent on going out to eat - consider staying in and cooking from home. Commit to a plan and stick with it. The last thing you want to do is dig yourself in more debt as you are trying to get out of it.
There are many things that debt consolidation will help you with:
Multiple payments into one
Not having to worry about multiple payments due dates.
Lower interest rate
When looking for a debt consolidation service, it is very important to keep any eye on what the interest rate will be. If your interest rate is higher on your new loan than it is for your current debt, you could end up paying more in the long run.
Debt is paid off faster
Assuming you have a new loan that has a lower interest rate, each payment that you make brings you much closer to climbing out of debt - since you will be paying more of the principal than the interest itself.
Avoiding credit damage
Missing a payment or coming short on one impacts your credit score in a negative way. Debt consolidation helps you to stay away from this pitfall.
Peace of mind
Besides the negative impact having debt can cause on your credit score and eligibility to purchase a home or car, there is a more personal impact on taking the first step to getting out of debt. Peace of mind. Knowing you don’t have a cloud of debt hovering over you can allow you to enjoy life more without the constant anxiety of the debt.
How to go about consolidating debt?
Debt can impact many areas of life - as well as come from many different sources. Credit cards, home ownerships, student loans, etc. Luckily there are programs out there to help you manage. Debt can be overwhelming to deal with - but hopefully the programs out there will help to lessen the anxiety debt can bring.
Credit Card Balance Transfers
Depending on your current credit score, there are a few credit cards that offer no interest for a promotional period - usually 12 or 18 months of 0% interest. These cards will allow you to transfer your outstanding credit card balances to the new card.
If you feel like you can pay off your credit card debt within the 0% promotional period, this might be the best route for you. Some companies even accept debt from non-credit cards - so it is important to review all your options.
Chase Slate: Promotional Transfer Fee: 0% APR on transfers for 15 months _APR After Promotion:_15.49%-24.24%
Citi Simplicity Card Promotional Transfer Fee: 0% APR on transfers for 21 months APR After Promotion: 13.49% - 23.49
Barclaycard Ring Mastercard APR: 8.5% (variable) Transfer Fee: $0
Discover IT 18 Month Balance Transfer Promotional Transfer Fee: 0% APR on transfers for 18 months. APR After Promotion: 11.49%-23.49%
A con of moving your credit card debt into one card is you can face a high credit card utilization ratio. This is a measurement of how much you owe vs what your card limit is. Having a high ratio can ultimately hurt your credit score. It is important to be mindful of that when searching to move your debt into one card. It is also very important to be mindful of how many promotional months you still have available. If you do not think you’ll be able to pay off the debt within the promotional month - before the APR increases - you might want to explore other options to decrease your debt. You wouldn’t want to be caught in a situation where this option can work against you and send you in more debt.
Home Equity Line of Credit (HELOC)
If you are a homeowner, you might have the option of taking out a line of credit using the equity you currently have in your home.
The benefit here is that you will be spreading debt you owe over a long period of time. The interest rates are typically low, but you could end up paying more in interest. Typically these loans require interest only payments during the first 10 years. However, the interest on HELOC may be tax- deductible.
Another thing to consider is the collateral. To take out a HELOC, you are putting your house up for collateral for the loan. Meaning if you find yourself not able to make the payments, your house is on the line.
While HELOC is used primarily for home upgrades and repairs, it is also can also be used for things that don’t necessarily increase the value of your existing home. You will need to speak to your bank about any special discounts or offers that might be available to you.
Debt Consolidation Loans
There are many organizations that offer personal loans which can be used to consolidate your debt. These typically offer lower interest rates as well as lower minimum payments depending on your credit score.
For the most part, personal loans have a fixed interest rate during the term of your loan - making budgeting easier to manage. This is important because part of debt consolidation is forming better spending habits. Knowing what you will be paying monthly is the best way to keep your budget under control.
Lower interest rates are typically reserved for individuals who have a good credit score. It is important to reach out to the Better Business Bureau before applying to any loan online. There are traps that you can potentially fall into especially if the lender is promising to offer loans out regardless of your credit score.
After You Consolidate
After you figure out what option is best for you - what now? You have all the debt you want under one loan - but you might still have a few cards that have a zero balance on them. Your first instinct might be to close out all your credit cards so you are tempted not to use them again. But this might not be the best course of action.
You already have credit built up on your name. Decreasing the amount of credit you have available can actually hurt your credit score. Earlier we mentioned that having a high credit card utilization ratio can hurt your credit score. After you consolidated your debt - your credit card utilization should be drastically decreased. Considering a factor to determine credit card scores is the utilization ratio - what might been used against your credit score before consolidating can now be turned to your favor.
Another reason why you should not close out your accounts is because credit scores are also determined by how long you have had an active account for. Closing out an account you had for years can actually hurt your credit score - because the history is then removed - and a factor for credit scores are history.
If the temptation is too great for you - you can always keep the credit cards open, but cut them so you can’t use them. If you feel the urge to close out the accounts. Do so over time - to spread out the negative impacts it might have on your credit score.
Remember that even when your balance on your cards are at zero - you are still in the same boat with the new loan. Don’t fool yourself into thinking you are out of the woods yet. It is important to focus on paying down your new loan as quickly as you can and not fall into the same pitfalls that got you there in the first place. If your loan allows it - sign up for automatic payments to be made, keep a healthy amount of cash in your checking account to ensure all bills are paid on time.
It is important to know that you are not the first person to go through this. Many people experience this in their lifetime and there are many options and resources available to you to not only get you through this, but to make sure this doesn’t have to happen again.
Ultimately you are the best judge to see what option is best for you. Discovering what is out there and the options you have is the first step to getting out of debt - and lucky for you, there are many choices. Before making any decision, it is important to talk to your bank, credit union and other debt consolidation companies to best weigh out your options.