CloseYes, but whether it’s the right option can depend upon your specific financial situation. A debt consolidation loan is an effective way to get out of debt, but it isn’t a viable option for everyone. Before you settle on a debt relief option, it’s important to understand your financial position. Without this understanding, you could end up choosing a debt solution that you can’t afford or commit to. Or, you can end up wasting money because there could’ve been a better solution that may have saved you more.
What are the three reasons why a debt consolidation loan is a good idea?
If your heart is set on using a debt consolidation loan as your way out of debt, you have to understand the factors that’ll make it a good idea. You need to look at these three factors and make sure they apply to your specific debt and financial situation.
1. If you want to lower high-interest rate debts
If lowering the interest rate isn’t possible, then it doesn’t make sense to consolidate. Why spend more than what you’re already paying for the combination of your debts? Even if it’ll simplify your payment terms, if you’ll end up paying a higher interest rate, you should stop and reconsider. Always opt for the lowest interest rate. The thing is, it’s possible to get a low-interest rate as long as you have a good credit score. If you don’t have a good score, you need to improve your credit behavior to bring your score up.
2. If you’re tired of juggling multiple credit accounts
It’s also a good idea to use debt consolidation loan if you want to simplify your monthly payments. When you get one loan to pay off your debts, it becomes easier to meet your payments. You don’t have to worry about keeping track of so many due dates and debt amounts. You only have to track one debt, and that should make it easier to avoid late payments.
3. If you need to improve your repayment terms
Finally, if there’s something in your repayment terms that you want to improve, this is probably the best way to do it. You can look for a loan that has the best terms, such as a shorter or longer repayment plan. You can also look into the fees and charges that your original lenders have imposed on you. If you find another lender with better terms who can help you pay off all your debts and consolidate, then go ahead and do so.
As much as possible, these three should be applicable to your debt and financial situation to make this debt solution a good idea.
Do debt consolidation loans hurt your credit?
The short answer is yes, but it’s important to clarify that it won’t have a significant effect. When applying for a loan, banks perform a hard credit pull, which can initially damage your credit slightly. However, if you take out a loan and make your payments on time, you’ll be actively building up your credit and improving your score. By the time you finish paying off your loan, your score should be at the same level, if not higher as before you took out the loan.
Can I use my credit card after debt consolidation?
Yes, although it’s important to make sure you’re making smart financial decisions. Credit cards can be easy to abuse because you don’t physically have to hand the money over. This can lead to spending money you don’t have. So yes, you can use a credit card after debt consolidation, but it’s important to continue to make good financial decisions so you don’t end up in debt again.
What do you need to make debt consolidation loans work?
The short answer is a high credit score, a stable source of income, and self-discipline. Even if you think a debt consolidation loan is the right choice for you, you have to make sure you qualify and will be offered a debt consolidation loan. Here’s a deeper look into the three important must-haves if you want a debt consolidation loan.
High credit score
This is a loan after all. You want to get the lowest interest rate that you can and the best terms. To do that, you have to prove to the lender that you’re a low-risk borrower. This is only possible if you have a good credit score. Having a high score means you pay your debts on time and don’t borrow too much.
A stable source of income
To get approval for the loan, you also have to show proof that you have a stable and steady source of income. After all, the lender needs to know that you’re capable of paying back the loan. If you can’t show that proof, it won’t matter if you have a high credit score. The lender won’t approve your loan.
Self-discipline
Finally, it’s very important to have self-discipline. Remember that a debt consolidation loan won’t solve all your debt problems. It’ll only make it easier for you to pay it back. You still owe the same amount of money if not more because of the fees you have to pay for the loan approval. This is why you have to discipline to pay off your loan properly. Set up a repayment plan and make sure it’s aligned with your monthly budget so you’ll always have the funds to pay back your loan.
If you have all three of these, then a debt consolidation loan is a good idea.
What are your debt consolidation loan options?
There are three main loan options when consolidating your debts; a straight debt consolidation loan, a personal loan, or a home equity loan. Once you’re sure that a debt consolidation loan is the right solution to your problems, the next step would be to figure out the type of loan you’ll seek. Here’s a little more about each type.
Debt consolidation loan
This is an unsecured loan that you can use to combine different debts. It’s exclusively used to pay off multiple debts. Sometimes, the fund won’t even pass through you. The lender will be the one to process the consolidation. It’ll require you to submit the details of all your debts so it can help consolidate all that you owe. Once the loan is approved, the new lender will get in touch with your original lenders to pay off the old debts. Until you receive a written confirmation from the lender that your original loans are paid off, you should continue with your monthly payments. That way, you won’t miss a payment. This is a great option if you have a high credit score. You can get the loan with a low-interest rate, which will help you save in the end.
Personal loan
This option involves another unsecured loan. However, unlike the debt consolidation loan, this isn’t inclusive, as you can use it on other things. For instance, if you qualify to borrow $30,000 and your debts are only $25,000, you are free to choose how you use the excess $5,000. Not only that, but you’ll be responsible for paying off your multiple debts. The lender will release the full loan amount to you and it’s up to you to pay off the other debts. If you suddenly decide to use it on something else, nobody can stop you. This is why you have to be disciplined when you get the money. Use it only as intended and borrow only what you need. To increase the benefits of this loan, you should have a high credit score to secure a low-interest rate.
Home equity loan
The last debt consolidation loan option is a secured loan. If you own your house and have a substantial amount of equity, you can use that to help consolidate your loans. Since this is a secured loan, it’ll be given at a low-interest rate. The collateral, which is your house, will make you a low-risk borrower. Of course, you could lose your house if you don’t pay back the loan, so make sure you have a repayment plan in place so don’t endanger your home.
Use this table to easily identify some of the main differences between these types of loans.
| Debt Consolidation Loan | Personal Loan | Home Equity Loan | |
|---|---|---|---|
| Type | Unsecured | Unsecured | Secured by home |
| Can the loan amount be for more than your debt? | No | Yes | Yes |
| Where will the lender make the payment? | Debtors | You | You |
| What is the risk level | High to medium | High to medium | Low |
| Will I get a good interest rate? | Dependent on situation | Dependent on situation | Dependent on situation |
| Is a high credit score required? | Yes | Yes | Sometimes |
How to choose between the three debt consolidation loan options
Choosing between a debt consolidation loan, a personal loan, and a home equity loan can be difficult. All these options are effective and can get you out of debt. However, some will work better for you than the others. If you want to benefit from this type of debt relief, you have to make sure your debt and financial situation suit the type of loan you choose.
For a debt consolidation loan
If you have a high credit score and you lack self-discipline, this is the right option for you. The high credit score is necessary if you want a low-interest rate. When it comes to your lack of self-discipline, we previously mentioned that the lender will take charge of the consolidation process; the funds may not even pass through your hands. That means it’ll go toward your multiple debts. There’s no danger of having the funds spent on something else.
For a personal loan
If you have a high credit score and are disciplined enough to use the loan as intended, then this is the right option for you. Since this is also an unsecured loan, the high credit score will help you get a low-interest rate on the loan. However, you need to be disciplined with your money because you’ll be in charge of paying off your multiple debts. You have to make sure you follow through as planned. Otherwise, you might end up with more debt than when you started. If you know you can’t control your spending urges, then it might be best to get a debt consolidation loan.
For a home equity loan
If you have a home, a low credit score, and you’re disciplined to use the loan as intended, then this is the right option to consolidate debt. This secured loan will give you the lowest interest rate compared to the other options. Of course, you have to make sure you can pay off this loan; if you fail to pay it back, you could lose your home in the process.
Admittedly, it can be confusing to choose among these options. You may want to check out debt consolidation reviews so you can read about the experiences of actual borrowers. By knowing what others have gone through, it might help you make a decision.
What will make a debt consolidation loan effective?
After choosing the type of loan you’ll borrow to consolidate your debts, you have to understand that the battle is far from over. Debt consolidation won’t solve your problem; it’ll only make it easier to pay off your loan. However, the journey toward paying off your debt is far from over. To ensure that you can avoid the common pitfalls of debt consolidation loans, here are the rules you need to follow.
Borrow only what you need
Always remember to borrow only what you need. This is especially true if you’re borrowing a personal loan or a home equity loan. You might be tempted to spend the extra money on unnecessary expenses. You have to be wise when it comes to deciding how you use the loan. Unless it’ll help you earn more or it involves a life or death situation, you should only borrow what you need to pay off your debts.
Understand the terms of the new loan
It’s also important to know the terms of the loan you’re borrowing. Make sure you know the charges and penalties that might be imposed on you. This knowledge will help you avoid them and keep you from unnecessary expenses.
Commit to a repayment plan
Before you borrow the debt consolidation loan, it’s advisable to have a repayment plan in place. If you don’t know how you’ll pay for the loan, then don’t borrow it. Additionally, when you have this plan, make sure you’ll stick to it to avoid encountering problems in the future.
Stop using more credit
While you’re paying off the debt consolidation loan, it’s important to stop using credit temporarily. Sometimes, paying off your credit card balance with the loan will make you feel like you owe less money. That will tempt you to use your cards again. When that happens, you’ll end up with more debt, so keep a lid on your spending and try to live frugally until you’ve paid off a significant portion of your debts.
When is debt consolidation loan a bad idea?
You have to realize that debt consolidation loan can be a bad idea if it doesn’t suit your debt and financial positions. Here are two situations that make this debt solution a bad idea.
If you need a debt expert to help you out
A debt consolidation loan doesn’t involve a debt expert. You’ll be taking charge of the payments. You have to discipline yourself to ensure that the loan will be used to pay off the multiple original debts. It’s also important to make sure you can commit to paying off your loan and not add more debt to it. If you think you don’t have the self-control to pull this off, you can opt for debt management instead. This option involves a credit counselor who can help you analyze your debt and financial situation. Through the information that you’ll get, you can create a Debt Management Plan that contains your repayment proposal. The credit counselor will help present this DMP to your creditors and lenders for approval. Once they approve, you’ll send a single monthly payment to the credit counselor, and he or she will take charge of disbursing the funds to the different creditors. While you’re going through the payment process, your credit accounts will be frozen. That means you’ll be forced to stop using credit until after you finish with the DMP.
If you cannot afford to pay off your balance in full
Many people try to convince themselves that they can pay off their debts as long as they’re given a lower monthly payment. While this is something a debt consolidation loan can do, it may not always be the best move. A lower monthly payment means you’ll stretch your balance over a longer payment period. Even with a lower interest rate, you’ll end up paying a lot more on the loan. If you want a lower monthly payment, you should probably think about debt settlement. This might be a better option because it’ll make debt reduction possible. Debt settlement involves a negotiation process. You’ll basically try to convince your lenders and creditors that it’s in their best interests to let you pay only a portion of the debt and have the rest forgiven. In most cases, they’ll agree if you have a settlement fund (lump sum payment) to offer or you’re on the brink of bankruptcy.
Think about these two scenarios before you set your eyes on using a debt consolidation loan to get out of your tough credit situation.
