Debt consolidation is a financial term that’s thrown around quite a bit. Aside from big purchases, refinancing, or taking out a mortgage, many lenders offer borrowers the ability to take out a loan just for consolidating debt. So what does debt consolidation mean, anyway, and where do you start?
In short, debt consolidation is a popular strategy for handling debt and the process involves taking out one large loan to pay off your other loans. Essentially, you’re rolling all of your debt into one nice, tidy loan.
In this article, we’re going to review everything you need to know about debt consolidation including how it works, when it works and when it doesn’t, and the key to navigating the process successfully so you’re fully prepared to move forward.
Best Debt consoliodation
How does debt consolidation work?
Depending on your financial profile, which includes things like your credit score, credit report, and overall financial health, the idea is to secure a debt consolidation loan that is lower in interest than your other debt sources, meaning you’ll pay less in the long run.
There are two main ways you can go about consolidating debt:
1. Using a debt consolidation loan
This is the most common route, which we’ve already touched upon. It involves taking out a fixed-rate loan to pay off your other debts. Just like with other loans, you’ll pay back the loan in monthly installments over a specified period of time.
2. Using a balance-transfer card
A balance transfer credit card allows you to move all of your debt onto a credit card. It begins with a preliminary 0% interest rate and gives you several months to make monthly payments without being charged interest. With this method, it’s important to understand what the interest rate will be after the 0% introductory rate ends.
When is debt consolidation a good idea?
Debt consolidation can be an excellent strategy to tackle your debt, but it isn’t for everyone. Consolidating debt is generally a good idea when you meet a few criteria.
- You have a plan in place to get your finances under control and you aren’t going to keep running up your debt.
- You’re able to make your debt consolidation payments on time.
- You have good enough credit to get approved for low-interest rates (lower than what you were paying on your other debts).
- The total amount of debt you have isn’t over 40% of your gross income. Keep in mind that this doesn’t include mortgage debt.
When is it a bad idea?
Remember when we said debt consolidation isn’t for everyone? Basically, if you do not meet the above criteria, it’s probably not a good idea to consolidate your debt because it won’t do much (if anything) to improve your financial situation. So if you have poor credit, tons of debt, and are continuously running your debt up further, debt consolidation will not provide a solution for you.
With poor credit, it’s unlikely that you’ll be able to secure a lower interest rate. Additionally, it’s smart to first address your spending habits and get your finances in order so that you’re easing up your debt instead of adding to it.
With that said, you probably needn’t bother with a debt consolidation loan or 0% balance-transfer card if you only have a small amount of debt that can be paid off within six months or so. In this case, it’s best to work on paying down your higher interest debt before tackling your other debt sources so you pay less on interest.
The 6 keys to successful debt consolidation
It’s never too late to start working on your financial health. After all, that’s why you’re here reading this article! Now that you know a bit more about debt consolidation and when it can work for you given your situation, let’s review the keys to navigating debt consolidation successfully.
1. Focus on your spending
While this may appear to be an “easier said than done” piece of advi