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Drowning in a sea of credit card bills, personal loans, and mounting interest charges can be an overwhelming and stressful experience. Many individuals in this situation turn to debt consolidation as a potential solution, hoping to simplify their payments and gain better control over their finances. But is debt consolidation a good idea for your specific situation?
Let’s go over the pros and cons of this strategy, helping you determine whether it’s the right choice for your unique financial circumstances. First things first…
What exactly is debt consolidation?
At its core, debt consolidation involves taking out a new loan to pay off multiple existing debts, effectively combining them into a single, more manageable monthly payment. This can include credit card balances, personal loans, or even student loans. The primary goals of debt consolidation are to:
- Reduce the overall interest rate. By securing a lower interest rate on the new consolidated loan, you can save money on interest charges over time.
- Simplify repayment. Instead of juggling multiple due dates and payment amounts, you’ll have a single, predictable monthly payment to make.
- Faster debt payoff. With a lower interest rate and a fixed repayment timeline, you may be able to pay off your consolidated debt more quickly than if you had continued making minimum payments on your existing debts.
- Improved credit score. Paying off credit card balances can decrease your credit utilization ratio, which can have a positive impact on your credit score.
The different types of debt consolidation
There are several ways to consolidate your debts:
- Debt consolidation loans and balance transfer credit cards are easy to apply for and very popular, especially for those who want to consolidate unsecured debts that don’t have prepayment penalties tied to them.
- Consolidation loans are great if you’d like the stability of budgeting to pay off your debts in equal installments over a set repayment period.
- Balance transfers are ideal for people who want the flexibility of making payments of varying amounts for an indefinite amount of time while interest grows.
It’s also possible to consolidate secured debts – like refinancing your home, for example – but this process is not always as straightforward as simply applying for new credit. Often, this type of consolidation requires consultation with an appraiser before a new loan can be negotiated.
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Potential drawbacks of debt consolidation
While debt consolidation offers several potential benefits, it’s important to also consider the potential drawbacks:
- Longer repayment period. Depending on the terms of the new loan, the repayment period may be extended, potentially resulting in you paying more in total interest over the life of the debt.
- Upfront costs. Debt consolidation loans may come with origination fees, application fees, or other charges that can add to the overall cost of the loan.
- Secured vs. unsecured debt. If the debt consolidation loan is secured by your home (e.g., a home equity loan), you’re putting your property at risk if you’re unable to make the payments.
Determining if debt consolidation is right for you
So, now that we’ve gone over the pros and cons, how can you decide whether debt consolidation is the best solution for your situation? There are three main factors that you should take into consideration:
- Interest rates: Carefully review the interest rate being offered on the new consolidated loan and compare it to the rates on your existing debts. Ensure that the consolidated rate is significantly lower to make the switch worthwhile.
- Repayment timeline: Evaluate the length of the repayment period for the new loan and ensure that it aligns with your ability to make the monthly payments. Avoid extending the repayment period too long, as this can lead to paying more interest over time.
- Credit impact: Consider how the debt consolidation process may affect your credit score. While reducing credit card balances can improve your credit utilization, the new credit inquiry and potential changes to your credit mix may have a temporary negative impact.
Explore alternatives
If you’re still unsure whether or not debt consolidation is right for you, explore other debt management strategies and see how they compare:
- Negotiating with creditors. Believe it or not, many creditors are actually willing to work with customers who are struggling to pay off their debt. Consider contacting your credit card companies and requesting a lower interest rate or a hardship program. These options can significantly reduce the amount of interest you pay each month, allowing more of your payment to go towards the principal balance.
- Seeking credit counseling. Credit counseling typically involves working with a nonprofit credit counseling agency to get help managing and paying off debt. By operating as nonprofits, these credit counseling organizations can focus on their core mission of empowering individuals to improve their financial well-being, rather than prioritizing profits. This nonprofit model helps maintain trust and credibility in the credit counseling industry.
- Implementing a debt snowball or debt avalanche approach. The Snowball Method involves paying off your smallest balance first, regardless of the interest rate. This strategy provides quick wins and a sense of momentum, which can be highly motivating. As you pay off each card, you can then redirect the minimum payment you were making towards the next smallest balance, creating a “snowball” effect. The Avalanche Method, on the other hand, prioritizes paying off the accounts with the highest interest rates first. This approach may take longer to see results, but it can save you more money in the long run by minimizing the amount of interest you pay over time.
Making the right decision
Debt consolidation can be a valuable tool in the right circumstances, but it’s not a one-size-fits-all solution. By carefully weighing the pros and cons, understanding your financial situation, and developing a comprehensive debt management plan, you can make an informed decision.
If you’re still on the fence about whether debt consolidation is your best path forward, consider reaching out to JG Wentworth. We offer access to personal loan providers that can offer you a loan used to consolidate your debt. If you have something particular in mind – low APR, flexible repayment terms, special introductory rates, and so on – we might be able to help you find what you’re looking for!*
SOURCES CITED
Egan, J. & Strohm, M., “The Debt Avalanche Method: How It Works And How To Use It.” Forbes. July 30, 2021.
Egan, J. & Strohm, M., “The Debt Snowball Method: How It Works And How To Use It.” Forbes. July 28, 2021.
* JGW Debt Settlement, LLC d/b/a JG Wentworth (“JG Wentworth”) has partnered with lenders to provide this loan referral service. JG Wentworth is not a lender and cannot ultimately decide whether or not you are approved for a loan. JG Wentworth does not determine or influence the amount of money you may receive from using this referral service.
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