The act of merging two or more loans into a single more enormous obligation is debt consolidation. Consumers who are saddled with a considerable quantity of high-interest debt frequently take this option.
“It is frequently used to consolidate credit card bills, auto loans, school loans, medical debt, or other forms of loans into a new loan,” explains Katie Ross, executive vice president of the organization American Consumer Credit Counselling. “The borrower would therefore just have to make one monthly payment rather than separate payments for each debt.”
In addition to simplifying your finances, debt consolidation ideally provides the borrower with more advantageous debt relief services and loan conditions, such as a lower interest rate. Therefore, debt consolidation is frequently the most effective approach for people to get out of debt.
Here are some of the key advantages.
- Pay off your debts sooner.
Taking out a debt consolidation loan may help you get on track to total payback sooner, especially if you have considerable credit card debt. Credit cards do not have a specific timeframe for paying off a balance, but a consolidation loan has fixed monthly payments with a distinct beginning and finish date.
- Simplify your financial situation.
You no longer have to worry about numerous due dates each month when you combine your debt since you have one payment to make. Furthermore, because the payment is the same each month, you know precisely how much money to set away. However, you should be aware of certain disadvantages to debt consolidation before taking out a loan.
- Maintain a consistent payback schedule.
If you utilize a personal loan to pay off your debt, you’ll know exactly how much you must pay each month and when your last payment is due. On the other hand, if you pay the minimum on a high-interest credit card, it might take years to pay it off in full.
- Increase your credit score
While a debt consolidation loan may initially reduce your credit score since you will have to undergo a rigorous credit investigation, it may improve it over time. This is because you will be more inclined to pay on time. In addition, because your payment history contributes to 35% of your credit score, paying a single monthly bill on time should considerably improve your score.
Here are some disadvantages:
- It will not address financial issues on its own.
Debt consolidation cannot ensure that you will not fall into debt again. If you have a history of living beyond your means, you may do so again after being debt-free. Make a reasonable budget for yourself and stick to it to avoid this. You should also start saving for an emergency fund that will allow you to avoid using credit cards in the event of a financial disaster.
- There may be some initial expenses.
Some debt consolidation loans have costs attached to them. These might include:
- Fees for loan origination.
- Fees for balance transfers.
- Closing expenses.
- Fees on an annual basis.
Before taking for a debt consolidation loan, inquire about all costs, including those for late payments or paying off your loan early.