How to Choose the Right Debt Consolidation Loan
Debt is an everyday part of life for many, but when it starts to get away from you it can become difficult to keep up with payments and even hurt your credit score. Debt consolidation can be a way to lessen the burden, before you get too far behind. With lower monthly payments or interest rates through combining all of your debt payments into a single one, it’s a form of refinancing to pay off other debt, usually with more favorable terms.
How Does Debt Consolidation Work
This is basically when you take multiple debts that are typically of higher interest rates and roll them into one with lower rates. An example would be if you owed on a couple of credit cards and it added up to $5,000 you owe with an average interest rate about 18%.
If you took a personal loan for debt consolidation and were approved for a lower interest rate, then you stand to save money by taking the loan to pay off the credit card debt. That’s how debt consolidation works. You consolidate debt and pay it off with a better option that costs you less.
Using a debt consolidation loan to take care of bills, credit card debt and other kinds can be more manageable since you don’t have to deal with different interest rates, payments and due dates. While it can sound like the answer for most, a debt consolidation loan isn’t for everyone.
When is Debt Consolidation Right For You?
The debt consolidation option is usually suitable when you are able to negotiate a loan with better terms such as a lower interest rate or monthly payments that help you to make payments on time. Your credit score is going to be a factor in whether you can qualify for a loan that would work.
There are times when the numbers won’t make sense, and other options to explore can include getting a 0% interest balance-transfer credit card, home equity loan, or 401(k) loan. Also, if the amount you owe is not all that much and you can pay it off within 6 months or so, you would only save a negligible amount by consolidating and it isn’t worth the bother.
You will also find that some online lenders might have an additional one-time charge called an origination fee that is from 1% to 8% of the loan amount. This fee is included in the loan’s APR, and used to cover the underwriting cost of the loan. Depending on your debt and interest rates, there can be times where a debt consolidation loan doesn’t make sense if it involves an origination fee and ends up costing you more. Run the numbers to determine whether it makes sense and can help you manage your money more effectively.
RELATED: 5 Things to Know When Looking for Personal Loans
When Debt Consolidation Can Work
Here’s an example of a situation where a debt consolidation loan could make sense. Let’s say that you have 3 or 4 credit cards where you carry a balance on each, and they have interest rates ranging about 18 – 22%. If you managed to make your payments on time and your credit rating was good, you might qualify for an unsecured debt consolidation loan around 7-8%. Clearly the interest rate is much lower and a significant amount could be saved. Probably half of what you may pay in interest in total, with this example.
The above scenario is not uncommon, and one of the many reasons unsecured personal loans are popular. Whether you use it for debt consolidation or home improvement, medical bills, vacations, weddings, divorces, or something else, it’s entirely up to you.
What to Know When Considering Debt Consolidation
When shopping for debt consolidation loans it can help if you are pre qualified or pre approved so that you are able to better compare the rates and terms available to you. It’s important to understand the difference between the two, how one can impact your credit score, and the other is not a guarantee of approval.
Even if you have bad credit personal loans can still be an option for many. While many lenders prefer to see a good credit score that is about 700 or higher, there are some lenders that are willing to work with you even when your score is low 600’s.
When considering personal loans for debt consolidation, sometimes it can make sense to focus on trying to improve your credit score before applying. There are times where a small improvement to your score can put you in another bracket and make you eligible for even better rates, so it pays to check beforehand, and if you don’t need the money immediately, it can be worth the time and effort to focus on improving your credit score before applying.