Consolidating debt is a commonly used method to deal with high-interest debt. But those who haven’t dealt with debt before may be left wondering what exactly they should know about the process.
What Do I Need to Know About Consolidating My Debt?
Debt consolidation is a process that involves combining multiple debts, generally high-interest debt like credit card debt, into a single debt that involves a lower interest rate. This can provide several benefits, including paying less interest over time, extending the loan repayment period, and simplifying the payment process. So how does someone know if debt consolidation is right for them?
Understanding Your Debt
Before an individual decides if debt consolidation is the best way to manage their particular financial situation, they should first understand exactly what types of debt they have. By listing out each of their debts by total amount owed, interest rates, and minimum payments, they can get a better look at their individual situation.
As debt consolidation works best for high-interest debt, it’s good to work out the average interest rate across all debts owed, and compare it to the potential interest rate of any debt consolidation loan that may be available. So what types of debt consolidation loans are out there and which one is best for consolidating debt?
What Are the Different Debt Consolidation Loans Available?
Debt consolidation comes in several forms, and not every form is right for every debtor. The most common type of debt consolidation loan is a personal loan. This is an unsecured debt, meaning that there is no underlying asset. Oftentimes, this means that the interest rate, and whether or not you’ll be able to get the loan at all will depend on your credit score.
Balance transfer credit cards are another form, generally offering an introductory interest rate of 0% for a set period. These frequently come with a balance transfer fee, however, so be sure to read any contracts closely before signing. For those with a home, a home equity line of credit is a type of secured loan that could offer a lower interest rate.
This comes at the cost of putting your home in danger of foreclosure should you miss several payments in a row, so it’s important to weigh that risk carefully.
Credit Score Implications
As with any loan, debt consolidation is likely to have an impact on the credit score of the borrower. Firstly, the creditor will perform something known as a “hard inquiry”, which has a negative, albeit temporary, effect on credit scores. Secondly, adding a new account lowers the average age of all credit accounts, an important factor in your score.
For balance transfer cards, if the card a consumer transfers to has a lower overall credit limit than their previous one, they’ll likely end up with a higher credit utilization ratio which lowers a credit score. It’s important to weigh those potential impacts, and assess whether they’ll outweigh the potential impacts of late payments they would’ve otherwise incurred.
Moving Toward a Better Financial Future
After consolidating debt, it’s important to take steps to mitigate the factors that caused the debt to grow in the first place. By taking steps to better manage their finances, an individual can take control of their particular financial situation and avoid many of the pitfalls that lead to high levels of debt. But, if it does happen, you at least won’t be stuck wondering, “What do I need to know about consolidating my debt”, and you’ll be better prepared to deal with the process.