Getting out of debt can be overwhelming, especially when you have to keep track of bills from more than one creditor. Let’s say you have multiple credit card bills, a car loan, various personal or payday loans and hospital bills to pay off. Perhaps one bill is due at the beginning of the month and another at the end of the month. They all have different interest rates and must be paid back to a range of creditors. Keeping on top of things and paying your bills on time can be difficult and discouraging.
A solution to this problem is debt consolidation. Debt consolidation means taking out a new loan, in order to combine multiple debts into one single, larger piece of debt. The new larger loan will usually have a lower interest rate and lower monthly payment, which can greatly benefit a borrowers financial situation.
Why consolidate your loans?
Putting all your debt in one place is not only smart financially, but it will also give you peace of mind as you pay off the loan. You won’t have to worry about which creditor to pay first, as now there is just one payment to one company.
Consolidating your debts will help you save a lot of money on interest. If you have a credit card with a 15% APR and a car loan with a 12% APR, you are losing a lot of money every month on interest. If you instead take out a larger personal loan at a 7% APR and use it to pay off the credit card and car loan, you will end up saving yourself a ton of money. Now that you have a lower interest rate and just one repayment to manage, you might even be able to erase your debt completely in a much shorter period of time.
One important thing to check for is that the personal loan you apply for doesn’t have a higher interest rate than what you are already paying. You should never consolidate a loan into a new loan with a higher interest rate, so keep the low interest loan out of your new consolidated loan.
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What kind of debt can be consolidated?
Consumers can consolidate many different types of debts, from private student loans to car loans and credit card debt. If you have multiple credit cards, consolidating them might be a very smart choice. Many credit cards have high APRs, and you will also need to keep track of making payments on time.
Combining personal loans into one new one is also a smart idea. If you have a decent credit rating, you can often qualify for a more competitive interest rate if you sign up for a debt consolidation loan.
Student loans can also be consolidated, however this is more common with private student loans, rather than federal student loans, which often already have a lower or subsidized interest rate.
If you have taken out business loans to help start a business or grow the one you already have, consolidating your loans can be very beneficial because it can help free up more capital and give you more cash, as now you’ll have one lower payment instead of multiple loans.
How can I consolidate my debt?
Many lenders offer specific debt consolidation loans, however you usually need to have a good credit score, and other meet other criteria, like a minimum annual income, minimum length of credit history and a low debt-to-income ratio.
Alternatively, if you currently have credit cards with high interest rates, you could instead get a balance transfer credit card. This type of card charges little or no interest on balance transfers during an introductory period, which means you can easily consolidate your credit card debt into one low interest place.
Another option is a secured loan or line of credit. Secured loans have much lower interest rates, due to the consumer offering the lender more security, in the form of home equity, car value or a deposit.
If you have multiple student loans, student loan consolidation can be a good option for you. Some lenders have a specific focus on student loans and refinancing, including SoFi, SallieMae and Navient. If you have numerous private student loans, you can also see what options your private bank has for debt consolidation.
What if I have bad credit?
If you have a bad credit rating, it is still possible to get a debt consolidation loan from some lenders. Another option is an installment loan. Installment loans have more relaxed eligibility criteria, and depending on how much debt you have, they may lend you enough to consolidate your debt into one place.
How does debt consolidation effect my credit score?
Another benefit to debt consolidation is that it will probably help improve your credit score. After consolidating your debts, you will likely be able to pay off your debt faster, leading to a decrease in your credit utilization ratio and an increase in your credit score. As you successfully pay your bills on time, you will also establish more payment history or even diversify your credit mix, which can both help improve your credit score.
One thing to remember, however, is that your new lender will probably do a hard check on your credit report, before you get approved for a loan, which may cause a temporary dip in your credit score. After a short period of making your payments on time, the debt consolidation will only improve your score though.