As of June 2018, Americans carry over $1 trillion in revolving debt, according to data from the Federal Reserve. And carrying debt can be troublesome if it has high interest rates. Credit cards, for example, had an average rate of 15.54% in the second quarter of 2018. That can make it hard for you to manage payments and pay down your debt sooner.
While it would be nice to wish our debt away, you may be considering the next best option: debt consolidation. It could help you save money and potentially pay down debt faster.
Like any financial strategy, debt consolidation isnâ€™t perfect. There are pros and cons to consider anytime you restructure your debt or take out a new loan.
The advantages of debt consolidation are often important enough for consumers to overlook any potential downsides. Thatâ€™s because debt consolidation has the potential to save you money while getting you out of debt.
Hereâ€™s a rundown of how debt consolidation could help you save money, along with the additional advantages that come with this strategy.
One of the biggest advantages of debt consolidation is the potential to save money and time on your debt, said financial planner Justin Pritchard of Approach Financial in Montrose, Colo. One goal of debt consolidation is to get a lower interest rate. With a lower rate, more of your payments are going toward your principal balance each month.
Imagine you have $6,000 in credit card debt at an APR of 15%. If you made a minimum payment of $120 each month, youâ€™d pay a total of $9,473 over seven years. But if you consolidated your debt into a personal loan with an 8% APR and made the same monthly payment, youâ€™d repay a total of $7,323 over five years instead. Thatâ€™s a savings of more than $2,000 and two years of loan payments.
Pritchard notes that high interest rates make it difficult to pay down debt, whereas a lower rate can help you make a bigger dent in your balance with each monthly payment you make. If youâ€™re able to consolidate to a lower rate and keep making the same monthly payment, you can make a lot of progress in a shorter amount of time.
Financial planner Neal Frankle of Credit Pilgrim said debt consolidation can simplify repayment. If you have a lot of different accounts, he said, itâ€™s easy to get disorganized and miss a payment. This could lead to both late fees and a ding to your credit score, which wouldnâ€™t help your situation.
By consolidating your debt into a single new loan, you can go from multiple monthly debt payments down to one. This could make it easier to stay on top of your payments and focus on your end goal, Frankle said.
Financial adviser Fred Leamnson noted that revolving debt, such as credit card debt, may be harder to pay off if youâ€™re still using credit. If you continue spending on your credit card while you make payments, you can get stuck in a cycle where your new credit card charges outpace any progress you make.
If you consolidate debt with a personal loan, you could opt for a fixed interest rate. That would make your monthly payment and repayment period easier to manage. Plus, you couldnâ€™t tack on more debt to your personal loan. Just be wary of accumulating new debt on your paid-off credit card.
While securing a lower interest rate can help you save money on your debt, consolidating with a personal loan or another financial product does come with risks.
Some of the main disadvantages of consolidating your debts include:
â€śFor people who have bad spending habits, I would recommend seeking help from a budget coach or financial planner first,â€ť he said. That way, you can get to the root of your problem and prevent a situation where you consolidate debt but continue racking up new debt.
Depending on how you choose to consolidate your debt, you may have to pay upfront costs. For example, personal loans can come with origination fees from 1 percent to 8 percent. Home equity loans, on the other hand, come with closing costs similar to those of a traditional mortgage.
These costs or fees can offset your savings, Pritchard said. For that reason, you should factor in any fees youâ€™ll pay to ensure debt consolidation is worth it. Also consider looking for debt consolidation options that donâ€™t charge any fees.
Before you consolidate debt to save money or speed up your repayment timeline, you may want to consider the different loan options available. Consider this breakdown of the popular debt consolidation methods, along with their pros and cons.
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3.09% To 14.24% APR
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