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What you need to know about debt consolidation

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If you’re drowning in countless credit card and loan payments, debt consolidation might provide the relief you’re looking for. Though it’s an effective option, debt consolidation isn’t the best choice for everyone. Read on to learn what debt consolidation is, how it’s done, and whether or not it’s right for you.

What is debt consolidation?

Debt consolidation is the process of combining multiple debts into a single, lump-sum payment. Consolidation is especially helpful for those who owe a handful of creditors and have trouble keeping track of all of their payments. Instead of paying a pile of bills at different times, debt consolidation eases the burden with a consistent, once-monthly payment. 

How does it work?

Debt consolidation is simpler than you might think. There are two primary ways you can combine your debt into a single payment: take out a debt consolidation loan or apply for a debt consolidation credit card. 

With a debt consolidation loan, you’ll receive the capital you need to pay off all of your debts at once. If you’re looking to pay off $6,000 in debt, for instance, a loan of $6,000 dollars will provide everything you need to correct your balance in one fell swoop. Once all of your accounts are paid off, you’re left only with your loan payment. Any loan, no matter the type, can function as debt consolidation payments. Those with good credit scores typically apply for loans from their personal bank or acquire a home equity loan. Don’t worry if your credit score is poor — debt relief companies offer loans with more lenient application requirements. 

A credit consolidation card functions in a similar way. Like a new loan, a new card will help you bundle your debts into single monthly payments. The process is simple — once approved for a new card, you can transfer balances from all of your old cards to the new one. 

When done correctly, debt consolidation will significantly boost your credit score. Though hard inquiries during the application process will ding you initially, your paid-off balance will improve your balance by tens (or even hundreds) of points. 

What’s the best option for me?

debt consolidation
Getty/Alexialex

Debt consolidation might sound like the answer you’re looking for, but don’t jump in too quickly. When considering debt consolidation, be sure to have clear, actionable steps to pay off your debts.

“Before deciding on debt consolidation, make sure you have a plan with a timeline that you plan to fully execute and not wander away from by allocating more debt,” notes personal finance expert Lizeth Andrew. “You must be 110% committed to being debt-free.”

Even if you have a plan, though, debt consolidation may not be your best choice. Evaluate your personal situation carefully before moving forward. Honesty is key — you aren’t doing yourself any favors by looking through rose-colored glasses.

“Debt consolidation is typically a good idea if you meet certain requirements such as having good credit, consistent cash flow, and a good execution plan,” says Andrew. “If you don’t meet the requirements I highly recommend the debt snowball or debt avalanche methods.”

If you have a plan and think you’re qualified, what comes next? Many choose the following paths. 

If you’re a homeowner…

If you own a home, your assets give you a unique advantage. Most likely, you’ll automatically qualify for a fixed-rate home equity loan or low-interest home equity line of credit (HELOC). If rates are favorable, you can also opt to refinance your home. The capital you gain from refinancing is a quick, painless way to pay off debts without incurring new debt or additional interest. 

If you’re a cardholder…

New cards are ideal for those looking to consolidate credit card debt or pay off debts without putting assets on the line. For the best possible results, research your options thoroughly before applying. Make sure you qualify for a card with an adequate credit line. If you’re trying to pay off $10,000 in credit card debt, don’t apply for a card with a $5,000 cap. Look for a card with a low or 0% APR rate, too. 

Once you’ve found a good option, be sure to read the fine print. Many cards raise the APR rate after an introductory period or require all balances to be transferred within a specified timeframe. In some cases, the debt you transfer is also subject to a transfer fee that’ll charge you a certain percentage (usually 3-5%) of the total amount.

Debt consolidation pitfalls

Debt consolidation is convenient, but it’s far from risk-free. Knee-jerk decisions could be your downfall. Sure, that loan or card might seem perfect, but don’t dive in head-first. You might find yourself in an even bigger hole. Research, research, research! Know the fees, fines, and payment schedules backwards and forwards. When your money and credit score are on the line, there’s no such thing as being over-prepared. 

Personal property loss, though uncommon, is a very serious risk of debt consolidation. Failure to pay off a personal or home equity loan may result in asset seizure. Thousands in debt is a struggle, but it’s nowhere near as bad as losing your home. Debt consolidation is never worth foreclosure. 

Ultimately, racking up debt is just as much a behavioral issue as it is a financial one. Clearing your balances will do wonders for your credit score, but it won’t eliminate the habits that got you in debt in the first place. Let’s face it — a zeroed-out account creates major temptation. Once your accounts are back in order, applying for a higher credit line or making some major purchases won’t seem like a big deal. Over time, though, you’ll find yourself back where you started. Resist the urge to spend and treat debt consolidation as what it is — a clean slate.

In summary

If you have a decent credit score, qualify for low-interest loans and cards, and are willing to alter your behavior, debt consolidation is a powerful way to get your finances back on track. Rolling your debt into an easy, once-a-month payment will make your life a whole lot easier. Before you know it, you’ll be free of credit card debt and in good standing with your creditors.

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