Debt consolidation is the process of paying off existing debts with a new, single debt source like a personal loan or credit card. In this article, we’ll cover the pros of debt consolidation, what to consider before consolidating debt, and whether it could be the right option for you.
What Does Debt Consolidation Mean?
In simple terms, debt consolidation is the process of combining multiple debts into one debt. So, instead of making multiple payments each month, you’re only making a single monthly payment to a single creditor. Keep in mind, to enjoy a single monthly payment, it’s necessary to qualify for a loan amount that’s adequate to consolidate all of your debts.
If you’re ready to get your debt under control, debt consolidation could be a great addition to your personal debt reduction plan. Keep reading to learn a few of the many benefits consolidating your debt could provide.
The Pros of Debt Consolidation
- Debt consolidation is a great method for paying off debt faster.
- Debt consolidation loans typically offer lower interest rates than most credit cards.
- Consolidating all of your outstanding balances results in one simple monthly payment (if you qualify for a loan amount sufficient enough to fully consolidate.)
- You can pay a single bill instead of multiple bills with different interest rates each month.
- Consolidating your debt and making consistent payments may even boost your credit score.
What to Consider About Debt Consolidation
These benefits differ slightly due to factors like the financial product you choose to consolidate your debt or the amount and type of debt. Below, you’ll find a few of the most common types of debt people consolidate, as well as the options they seek to get the debt consolidation process started.
Types of Debt and Financial Options
Common types of debt that you can consolidate include:
- credit card and retail credit card debt
- medical bills
- car and home repair bills
- personal loan debt
Some of the most popular ways to consolidate debt include:
- credit cards via a balance transfer
- home equity loans, if you have equity in your home
- borrowing from a 401(k) or other retirement plans
- debt consolidation loans
There are three important things to consider when you’re thinking about consolidating debt: the amount of debt you have, the amount of interest, and how much time it’ll take to pay it off.
1. Consider How Much Debt You Have
Before you consolidate your debt, you’ll need to know the amount of debt you have. Once you have that figured out, you can calculate how much you want to consolidate.
To get started, add up all of your debt from all of your creditors and determine which ones you want to consolidate. From there, you can decide what type of debt consolidation to choose.
For example, if you owe $10,000 in credit card debt at an interest rate of 20% and pay off $375 each month over three years, you’ll pay approximately $3,374 in simple interest for the full three years. In total, you’ll have to pay about $13,374 over those 3 years to pay off this debt*.
If you apply for a simple-interest debt consolidation loan on a three-year term for the $10,000 and qualify for an interest rate of 13%, you could be paying a monthly payment of $337 and pay approximately $2,129 in interest*.
By opting for the simple-interest personal loan, you’d pay around $12,129 instead of $13,374, saving you more than $1,200 over 3 years.
2. Consider the Cost of Interest
When you’re thinking about which debts to consolidate, it’s important to consider how the cost of interest will add up.
Once you know how much it’ll cost to repay your debts, you can figure out if it’s a smart financial decision to consolidate them. If debt consolidation could save you money, it may be an option worth pursuing.
3. Consider the Timeframe
Before deciding to consolidate your debt, it’s crucial that you consider how long it’ll take to pay off your new obligation. Creating a monthly budget will help you determine how much money you can pay each month to pay off your consolidation loan and choose the terms that’ll work best for you.
How Does Debt Consolidation Work?
If you’d like a hand consolidating your debt, many companies offer debt consolidation programs that help you do exactly that – typically for a price. The good news is you can also consolidate debt on your own or with a financial advisor.
Seeing your full credit report is a great place to get started. See it now – totally free – in Best Egg Financial Health.
Want to learn more about how debt consolidation works? Click the link for detailed information about the process and to learn about the differences between debt consolidation, debt settlement, and debt management. If you’re interested in learning more about debt consolidation loans, we’ve got you covered there too.
*Savings determined using CreditKarma’s Debt Repayment Calculator.