Many people use loans and other financing to access additional money. It takes much less time to get a mortgage than it takes to save enough money to make an all-cash offer. Consumers who need $500 for an emergency expense can immediately get the money they need from a loan if they do not have enough money in their bank accounts.
All of these loans offer extra money in the beginning, but borrowers then have to repay the loan over time. Accumulating too much debt and not raising your income can make it more difficult to afford the monthly payments. It’s also possible to have many types of debt, which makes it easier to forget one of them or feel overwhelmed. Consumers in this situation may consider a debt consolidation loan to reduce their financial stress.
Debt Consolidation Loans
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What are Debt Consolidation Loans?
Debt consolidation loans are large loans that let you group all of your smaller loans together. A borrower uses this loan to pay off the balances of their other debt, such as credit card debt. The debt consolidation loan usually has a lower interest rate. You can even adjust the loan term and make it longer than your current debt, so you have lower monthly payments.
The Need for Debt Consolidation
Debt consolidation loans make it easier to manage your financial obligations. You can end up with a lower monthly payment and a lower interest rate. Debt consolidation streamlines your debt into a single financial product instead of having it scattered across many smaller loans, credit cards, and lines of credit.
How Debt Consolidation Works
This overview will cover how debt consolidation works. Here’s what you need to know before you get started.
The Process of Debt Consolidation
Debt consolidation involves taking out a large loan that covers the debt for your smaller obligations. You will have to get a debt consolidation loan, which can be anything from a personal loan or a line of credit. You then use the capital from this loan to pay off your other loans. Eliminating your smaller loans and securing a lower interest rate will make your debt more manageable.
An Example of Debt Consolidation
Assume a borrower has five smaller loans with the following amounts and terms:
- Loan 1 — $5,000 with a 15% interest rate
- Loan 2 — $3,000 with a 10% interest rate
- Loan 3 — $2,000 with a 27% interest rate (credit card debt)
- Loan 4 — $1,500 with a 12% interest rate
- Loan 5 — $500 with a 16% interest rate
This borrower doesn’t want to make five separate loan payments. Furthermore, the interest rates on these loans are high, especially the credit card debt. In this example, this borrower manages to secure a $12,000 personal loan with a 10% interest rate.
The borrower proceeds to pay off all five loans and now only has the consolidated loan. While a 1-year term accelerates the payment plan, it also results in much higher payments. You can stretch out the loan to 5-10 years to make the monthly payments easier to cover.
Debt Consolidation Loans
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A personal loan helps you cover expenses and consolidate debt. Discover how the MoneyLion Personal Loans Marketplace can provide you capital.
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Types of Debt Consolidation
Consumers can choose many types of debt consolidation products. These are some of the top choices to consider.
Debt Consolidation Loans
Some lenders offer loans specifically designated for debt consolidation. These loans are usually fixed installment loans. You will receive capital immediately and make the same monthly payment until you repay the loan.
Personal Loans
Personal loans allow you to borrow money upfront and make monthly fixed payments. Longer terms result in lower payments but higher interest payments in the long run. Shorter terms result in higher monthly payments but save you money on interest. You should opt for a longer term if you need extra space in your budget.
Line of Credit
A line of credit contains funds you can borrow and repay at any time. Lines of credit have lower monthly payments in the beginning, but after the draw period, the remaining balance gets converted into a loan. Most lines of credit have variable interest rates, and you only pay interest when you borrow against the line of credit. Paying off a line of credit sooner will limit interest accumulation.
Balance Transfer on Credit Cards
You can transfer funds from one credit card to another. While both credit card issuers may charge fees for this transfer, you can get a fresh start with an introductory 0% APR for 12-18 months. That offer gives you time to pay off your credit card debt without interest accumulation. High-interest rates are a key reason why many people stay in credit card debt. It is normal for credit card APRs to reach anywhere from 20%-30%, so any relief in this area can be significant for your finances.
Home Equity Loans
If you have a home, you can tap into your equity to cover debt. Home equity lines and home equity lines of credit let you use your home’s value to eliminate financial obligations like credit card debt. Since these are secured loans, the interest rates are usually lower. Lenders will assess your debt-to-income ratio and typically limit how much you can borrow based on your home’s equity position. Most lenders will not let your loan-to-value ratio exceed 80% (i.e., if you have a $500,000 home, you cannot borrow more than $400,000). However, some lenders stretch this limit to 95%.
Student Loan Consolidation
You can swap your old student loan for a new one with better terms. Adding more years to the backend of your loan will reduce your monthly payments. It’s even more beneficial if you can also secure a lower interest rate.
Debt Consolidation Loans
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Explore Bread Loans, a convenient and practical personal financing option with competitive rates and flexible terms.
A personal loan helps you cover expenses and consolidate debt. Discover how the MoneyLion Personal Loans Marketplace can provide you capital.
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Pros and Cons of Debt Consolidation
Are you on the fence about using debt consolidation to group your debt under a single umbrella? These are some of the pros and cons to consider before getting started.
Pros
- Lower monthly payments: You can reduce the monthly payment on your financial obligations with a longer term.
- Lower interest rate: You might be able to get a lower interest rate for your debt consolidation loan. You’re almost guaranteed to get a lower interest rate for this loan than the current rate on your credit card.
- Rebuild your credit score: Lower monthly payments are easier to pay off on time. These on-time payments strengthen your payment history, which makes up 35% of your score.
Cons
- Staying in debt longer: Extending your loan’s duration means you will have monthly payments for a longer amount of time.
- Fees: Each loan has origination fees that you will have to pay. A debt consolidation loan means extra costs, and your current loans may have penalties for early payments.
Debt Consolidation Loans
Discover how a Current Paycheck Advance works and if it can strengthen your finances. This Current review covers the details.
Explore Bread Loans, a convenient and practical personal financing option with competitive rates and flexible terms.
A personal loan helps you cover expenses and consolidate debt. Discover how the MoneyLion Personal Loans Marketplace can provide you capital.
Do you need a cash advance, but you don’t want high-interest rates? Learn how a 0% APR MoneyLion Instacash advance can help.
How to Choose the Best Debt Consolidation Loans
Choosing the best debt consolidation loan is an important decision that can impact your finances for years to come. These are some of the factors to consider when shopping around for a good loan.
Understanding your Debt Situation
Know how much you need and how much you can pay each month. Getting a full scope of your financial obligations can help you ask for the right loan amount and establish a realistic payment plan.
Comparing Interest Rates
Interest rates are one of the most important components of any loan. A high-interest rate will increase your monthly payments. Debt consolidation will only save you money if the debt consolidation loan has a lower interest rate than your current debt.
Evaluating Loan Terms
Determine how long you need your loan to last. If your budget is tight, you should pick a loan with more years on it to spread your monthly payments across more intervals. Longer loans are easier to pay off each month.
Long-term Consideration for Debt Consolidation
Borrowers should assess their long-term financial plans and establish checkpoints along their journeys. This planning can help borrowers use their debt consolidation loans more effectively and not find themselves relying on loan after loan. Debt consolidation can improve your credit score by helping you stay on top of your payments. A higher credit score can result in lower interest rates for future loans if you need to borrow money again in the future.
Debt Consolidation Loans
Discover how a Current Paycheck Advance works and if it can strengthen your finances. This Current review covers the details.
Explore Bread Loans, a convenient and practical personal financing option with competitive rates and flexible terms.
A personal loan helps you cover expenses and consolidate debt. Discover how the MoneyLion Personal Loans Marketplace can provide you capital.
Do you need a cash advance, but you don’t want high-interest rates? Learn how a 0% APR MoneyLion Instacash advance can help.
Common Mistakes in Debt Consolidation
While debt consolidation offers many benefits, avoiding some of the most common mistakes in the process is crucial. Staying away from these mistakes can help you save more money with your loan and become debt-free sooner.
Overlooking the Root Cause of Debt
A debt consolidation loan is the starting point to a better financial future. However, a loan alone will not help. Loans reduce stress, but it is essential to assess how debt accumulates. Borrowers should consider what brought them to the point of needing a debt consolidation loan and seek solutions. Carefully looking over expenses and minimizing non-essentials is a good starting point, but it has a limited ceiling. Developing skills that can lead to a higher income and picking up a side hustle can have a better impact and help you pay off debt sooner.
Ignoring the Terms and Conditions
The terms and conditions detail fees, penalties, and other rules. Overlooking the terms and conditions can result in a bad deal, making it more difficult to get out of debt. Read the fine print before committing to a loan.
Failing to Consider Personal Financial Discipline
Building your financial discipline can help you stay on top of the monthly debt consolidation loan payments and reclaim your finances. Creating a plan and knowing how you will pay your debt on top of your other expenses can put you in a better position.
Does Debt Consolidation Hurt Your Credit?
Debt consolidation will briefly hurt your credit because of a hard credit check. Most lenders will initiate this credit check before giving you a loan for debt consolidation. However, debt consolidation can add more points to your credit score in the long run by making it easier to stay on top of your payments. A hard credit check only reduces your credit score by a few points and is easy to recover from.
Debt Consolidation Loans
Discover how a Current Paycheck Advance works and if it can strengthen your finances. This Current review covers the details.
Explore Bread Loans, a convenient and practical personal financing option with competitive rates and flexible terms.
A personal loan helps you cover expenses and consolidate debt. Discover how the MoneyLion Personal Loans Marketplace can provide you capital.
Do you need a cash advance, but you don’t want high-interest rates? Learn how a 0% APR MoneyLion Instacash advance can help.
How to Qualify for Debt Consolidation Loans
Lenders will check to see if you qualify before giving you a debt consolidation loan. These are some of the things they will look for in your application.
Financial Evaluation
The lender wants to make sure you can afford the monthly payments. Lenders will look at your income and total debt. Many lenders set a maximum debt-to-income ratio they will accept from any applicant. Paying off existing debt and generating more income will improve your debt-to-income ratio and increase your likelihood of getting approved.
Credit Score Requirements
Most lenders have credit score requirements for debt consolidation loans. While getting a loan is possible if you have a 600 FICO score, raising your score will increase your options. A higher credit score will result in a lower interest rate.
Conclusion: Keys to Successful Debt Consolidation
Debt consolidation helps borrowers get back on their feet and keep up with monthly debt payments. However, debt consolidation is just the starting point. Looking for other ways to strengthen your finances, such as developing new skills or picking up side hustles, can lead to a meaningful impact. Debt consolidation helps you with current obligations. However, a closer look at the root causes of falling into debt can help borrowers become debt-free in the future.
