When you have multiple credit cards with balances and a loan or two in your name, it’s easy to feel as if your payments are getting out of control. Debt consolidation offers the promise of stress relief and savings. While that’s often the case, it’s not always that simple. So, before you sign up for a consolidation plan, analyze your situation to be sure you’re making a good financial decision for you.
Before you get started, check the details of your current credit report. If you haven’t requested one in the last 12 months, you can get a free report with no strings attached from www.annualcreditreport.com. In fact, if you haven’t taken a look in the last 12 months, you should check this out regardless of whether or not you’re considering debt consolidation. A credit report will list all your outstanding debts and help you understand what type of offers are available to you. The higher your credit score, the better financing deals you’ll find.
Consolidation in a Nutshell
Here’s the idea behind consolidation: instead of juggling various payments at a variety of rates between a long list of different creditors, you make one payment to one creditor at a rate that’s (hopefully) more affordable than most, if not all, of the others. To achieve this, you take out a new loan and use the funds to pay off all (or most of) your outstanding debt.
When to Consolidate
When you’re considering a consolidation loan, the variables to weigh include the size of your monthly payment, the interest rate, the loan term (length), and the conditions of the loan. Generally, the most important factor to consider is whether you’ll save money or pay more by consolidating. Calculate what you’ll spend to pay off your debts as they stand. To do this, multiply the number of payments remaining on each debt by the size of the payment (ex: 34payments x $70/mo. = $2,380 to pay off loan/credit card). Total your results across all debts for an idea of their overall cost. You can use this figure to compare with a consolidation loan.
See if the lender you’re considering charges an origination fee. Origination fees are rolled into your APR (the interest rate they charge) and can cost you an extra one to six percent. If your credit score isn’t great, adding a cosigner to your loan can dramatically lower your interest rate.
A good case for consolidation is if the total amount required to pay off the consolidation loan is significantly lower than the amount necessary to pay off your debts individually. For example, a young person without a good credit rating may have taken out a high-interest or “payday” loan, but now they can find much better rates on a consolidation loan from their credit union.
Consolidation might still make sense for you even if it is more expensive in the long run. If your current monthly payments are simply too high for you to manage, and you know you can make the commitment to a longer term of lower payments, a consolidation loan may be the right move. Think carefully before you go this route, though, because the longer term represents a significantly greater cost. And this may feel like a never-ending drain on your finances.
Another common situation that requires careful thought is the use of home equity loans. A home equity loan may let you secure a very low rate against the equity you have in your house. While the low interest rate is very attractive, you must be absolutely sure that you can make all the payments. If not, you could end up without a roof over your head.
Some Closing Advice
Whatever you decide to do, don’t make the mistake of thinking your debt is gone. Consolidation is a helpful step, but it will only work in addition to avoiding extravagant and unneeded spending. It’s important to closely monitor your spending and avoid taking on additional debt. It may help to consult with a financial planner to reach a solution that meets your specific needs.