Even though most people try to stay out of debt, sometimes itâ€™s hard to avoid. Over time, you might start to accumulate a number of different loans that served different purposes. This is commonly seen with student loans. In order to afford an education, students may take out debt each year to pay for tuition and other costs.
However, this problem isnâ€™t exclusive to those who owe student loans: in fact, many people run into the frustrating dilemma of having multiple consumer loans in repayment.
To clean up their repayment process â€” and to possibly get a better interest rate or repayment term â€” some people turn to debt consolidation. But is debt consolidation a good idea? And if so, when is it right for you?
Debt consolidation is a process that rolls all of your existing debt into one, convenient loan. This means you could go from having multiple loan payments from different lenders with different repayment terms, to having one payment each month with a single lender.
The debt consolidation loan (often a personal loan) is used to pay off all of your other loans. This can be viewed much like a balance transfer â€” youâ€™re transferring the balance of all of your loans to one bigger loan.
The lender providing your loan typically provides you with a lump sum payment to repay all of your debt, or it works directly with your other lenders to pay off your loans for you as part of the consolidation process.
You can consolidate a wide range of debt types, including:
Debt consolidation can only really work if you can secure a personal loan with an interest rate that is lower than what you are currently paying on your debts. That way, youâ€™ll save money on interest over time after consolidating.
Finding a lender can be difficult. You may consider local banks and credit unions. But online lenders may have better rates and terms. To help you shop lenders, consider LendingTreeâ€™s personal loan tool. Using the tool, youâ€™ll enter some personal information plus what youâ€™re looking for in a loan. Afterward, youâ€™ll receive loan offers, which you can compare to find the best deal for your credit score.
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Debt consolidation isnâ€™t for everyone, but there are several scenarios where this course of action would make sense for your unique financial situation.
If youâ€™re considering debt consolidation, youâ€™re looking to get a better deal on your new, consolidated loan than what you already have. If youâ€™re paying high-interest debt (such as credit cards or payday loans), consolidating at a lower interest rate could save you money on interest. (Find out how to view your credit score here.)
Sometimes life happens, and we end up with debts that are unavoidable in the moment. A medical emergency that your savings couldnâ€™t totally cover is an excellent example of this type of unavoidable debt. If youâ€™re working to put a plan in place to stay out of debt in the future and are looking to simplify your debt repayment, consolidation may be for you.
This might mean a shorter repayment term or fewer fees to ensure youâ€™re making the most out of a new loan.
If you have a number of different loans and are running the risk of missing a payment or overpaying due to high interest, it might make sense to consolidate them all to simplify your financial life and help you pay down your debt more quickly.
Although debt consolidation can be a huge help in many cases, there are certain situations where it doesnâ€™t make sense to consolidate your debt.
Debt consolidation shouldnâ€™t be used as a method to free up more cash flow to continue spending. If you find that your debt is largely consumer debt, and that you have no intention of reevaluating your budget or your lifestyle to support your debt repayment journey, consolidation isnâ€™t going to make things better â€” itâ€™s just going to act as a short term fix to your lifestyle problem.
Although itâ€™s commonly the case that a debt consolidation loan will come with better interest rates and repayment terms, this isnâ€™t always true. If consolidating your debt is going to force you to repay your loans at a higher interest rate, youâ€™re better off keeping your multiple loans (even if itâ€™s frustrating to juggle them all simultaneously).
The interest rate youâ€™re able to secure is largely dependent on your credit score. If your score is less than stellar, youâ€™ll have to pay close attention to what interest rate youâ€™re offered, and whether itâ€™s actually a better solution than simply staying the course and paying down your multiple debts.
Sometimes, debt consolidation services have an origination fee of between 1% to 8%. If your ultimate goal is to save money through debt consolidation, this may not work for you.
Donâ€™t just assume that debt consolidation is the answer youâ€™ve been looking for â€” do your research first. You might find that sticking with your numerous debts and paying them down at their reasonable interest rates makes the most sense until youâ€™re able to get your spending habits in check, or until youâ€™re able to raise your credit score by consistently paying them down.
There are several risks and downsides to debt consolidation that you need to be aware of:
When you first consolidate your debt, you may see a minor dip in your credit score: this is because the lender youâ€™re applying with will do a hard credit inquiry after you fill out your application. If you apply with multiple lenders, multiple hard credit inquiries will push your credit score down. However, you can avoid this problem by getting pre-qualified with multiple lenders, and only filling out an official application with one of them to reduce the number of hard credit inquiries on your credit report.
By using a debt consolidation service, like a personal loan, your total credit utilization doesnâ€™t go down. So, even though your credit card is magically paid off by your new consolidated loan, that doesnâ€™t mean you get to start racking up more debt. Doing so will cause your credit score to go down, and you may end up in an even stickier situation than you were in before.
Youâ€™ve likely been paying back your existing debts at a high interest rate for a given length of time. Sometimes, people pay back multiple debts for years before they consider consolidation. Then, when you apply for consolidation, they might extend your repayment term even further â€” meaning youâ€™re technically paying â€śextraâ€ť interest for the convenience of consolidation. However, you can fix this problem by working to pay your debt back before your repayment period is up and, in turn, driving down your principal (and the total interest you have to pay).
Some debt consolidation loans have origination fees to process your new loan. Watch these fees closely to make sure theyâ€™re not unreasonably high â€” if they are, consider looking into another debt consolidation method.
Debt consolidation isnâ€™t usually intended to be a long-term solution. Instead, debt consolidators shorten your repayment timeline. This can be incredibly helpful if youâ€™re looking to get out of debt quickly, but it also may mean higher monthly payments and an increased likelihood that youâ€™ll default on your loan.
If youâ€™ve looked into debt consolidation, and have determined it isnâ€™t the right choice for you, you have several alternatives to consider.
Make sure you look at all of your options when trying to consolidate your debt â€” you never know what you might find, or whatâ€™s going to work best for your long-term financial goals. If you do choose to pursue debt consolidation, make sure to shop around with different lenders. Being able to compare different interest rates, fees, and repayment terms, can help you ensure that youâ€™re getting the best loan as you start to move toward debt free living.
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