Taking out a loan could be one of the best financial decisions you ever make. Unfortunately, it could also be one of the worst. Loans stick with you for a long, long time, sometimes decades, as you pay them off in increments and the interest compounds every month.
People take loans out for all kinds of different reasons. We take out loans to finance our education to get a better, more meaningful job. We take out loans to afford to buy cars that can get us to those jobs. We take out loans to buy homes so we have somewhere nice to go after we get out of work. We take out loans to make ends meet and pay our bills, as well as to pay for sudden emergency expenses. If you need something now but you don’t have the money in the bank, a loan may be the answer.
When we take out all these different loans, or even just a few of them, we run up quite a bit of debt. And, with debt, one of two things is likely to happen. We keep up with our payments, budget responsibly, and pay the debt off, without it affecting our lives too much. Or, we struggle to keep up with the payments, live paycheck to paycheck, and fall behind.
You know that taking on a loan can get you much-needed money. You also know that getting that money puts you into long-term debt. However, did you know that a loan could actually help you get out of debt as well?
How can a loan help you get out of debt?
It seems counterintuitive that a loan could help you get out of debt. After all, loans are what cause most of our major debts. We take on loans to get a large sum of money quickly, and we pay that sum back slowly, with added interest. Loans equal debt, don’t they?
That’s correct, but it’s also thinking too short-term. After all, there are all different kinds of debt. We take out student loans as an investment in our future, confident that the extra income we’ll be able to earn due to our degree over our lifetime will vastly outweigh the financial burden of the loan. We go into debt in the present, but we, hopefully, come out ahead in the future.
In this case, we’re talking about a loan that, in the end, actually helps eliminate the burden of our debt quicker, and on friendlier terms. It’s called a debt consolidation loan, and it’s been effective in helping people across the country get out from under their debt and live financially stable lives.
What is a debt consolidation loan?
When you take out a debt consolidation loan, you borrow enough money from a lender to pay off all your other debts at once. Instead of owing a lot of money to many different creditors, you now only have one creditor to worry about, consolidating your debt into a single monthly payment.
Debt consolidation loans are attractive to individuals who owe a lot of debt to multiple different creditors. For starters, you only have to keep track of a single monthly payment instead of several different minimum monthly payments, helping keep stress levels down and your life a bit more organized.
In addition, debt consolidation loans can often save individuals a lot of money, both now and later.
In the short term, a debt consolidation loan can save you money by reducing the portion of your income that goes towards paying off your debts each month. The single monthly payment may be lower than the sum total of your former monthly minimum payments, keeping more money in your pocket at the end of the month.
In the long term, a debt consolidation loan can save you money by reducing the overall amount you pay in interest on your debt. If the interest rate on your debt consolidation loan is lower, it causes less interest to compound each month on your debt, so more of your payment goes toward paying down your actual balance.
Ideally, with the extra money you’re saving, you’ll be able to devote more of your income toward paying down your debts, helping bring closer the day when you are free from debt.
Pros of debt consolidation loans
Besides having only a single monthly payment to deal with each month, a debt consolidation loan is also a great way to pay debt off faster while lowering your overall interest rate. Toss in the protection this can offer your credit score and you have a very attractive option.
A single, consolidated monthly payment
With debt consolidation loans, all your debt is rolled into a single monthly payment with a single due date that’s much easier to keep track of than the multiple due dates you might be dealing with when you deal with multiple different creditors. Having a single due date helps cut down on your stress level while making your debt easier to get a handle on and helping you avoid falling behind on your payments.
Potentially lower interest rates
The interest rates for debt consolidation loans also tend to be much lower than the interest rates you would get from multiple different sources of debt, especially credit cards. This lower interest rate means that you’ll pay less each month, and over the life of your debt, toward interest and more toward the actual debt balance.
Faster payoff of debt
With lower interest rates and, ideally, lower monthly payments as well, you’ll actually be able to get ahead of your debt and pay it off faster. By devoting more of your income each month toward paying down your debt, you speed up the debt repayment process and help make the day you’re debt free come even sooner.
Potentially avoided damage to your credit score
Debt consolidation loans can also help you avoid damage to your credit score. This is because debt consolidation loans eliminate the multiple different debt payments you might be making. These payments are hard to keep track of and easy to fall behind on, and when you start to fall behind on your debt payments, it can wreak havoc on your credit score. Debt consolidation loans may also prevent you from having to take drastic measures to eliminate your debt, such as declaring bankruptcy, which can have a devastating effect on your credit score for 10 years or more.
Cons of debt consolidation loans
As with anything else in life, there are downsides to debt consolidation loans. People often lean on these risky loans as a way to avoid treating the root cause of the problem. Of course, that assumes they even qualify, because you often need to have decent credit to gain approval for a debt consolidation loan.
You need decent credit to qualify
A debt consolidation loan is still a loan, and to get a decent loan, you need decent credit. Your credit score, after all, is ideally a measure of your creditworthiness and your ability to pay off debt. Lenders look at your credit score first when deciding whether you’re a safe person to lend to, and if your credit score is faltering, that might prevent you from even entering consideration for a debt consolidation loan.
This can make paying off debt even more difficult for people who have been in debt for a while since those individuals are more likely to have struggling credit scores due to missed past payments or frequent, high-risk use of credit. Often, these people could use a debt consolidation loan the most, but they can’t find any lenders who are comfortable enough to work with them.
It can be risky
Generally, there are two different types of debt consolidation loans: unsecured loans and secured loans.
Lenders extend unsecured loans to individuals based on their creditworthiness. The lender looks at your credit score, your financial history, and other factors to determine if you are a smart investment who will be able to pay back your loan on the terms agreed to. If all looks good, they’ll offer you the loan based on credit and not tie to any particular asset. This added risk to the lender is often offset by higher interest rates and other changes to the terms of the deal, but not always.
Secured loans, on the other hand, can be extremely risky to take on. With a secured loan, your loan is tied to a piece of collateral that you own. Collateral here means any major asset that you own that you could offer up to the bank in the event that you can’t keep up with your payments. It could be your home, your car, or any other major asset that holds enough value. Banks ask for this collateral as insurance for offering you the loan if they aren’t certain they can trust you to pay it back in full. If you fall behind in your payments, they may seize ownership of the collateral you’ve offered up to make at least some of their money back. They may offer to lower your interest rates or favorably alter other terms of the loan if secured with collateral, but that doesn’t make the act up putting up collateral for the loan any less risky.
It could be treating the symptom, not the disease
Often, the individuals who find themselves in large amounts of debt to multiple different creditors did it to themselves, but not intentionally. They simply lived beyond their means, using credit to finance luxury purchases that they otherwise could not afford, planning to pay off their debt another day, interest included. These purchases might be for fancy new clothes, expensive evenings out, home furnishings, entertainment… anything that you don’t need but feel like you do, at least during a moment of weakness. It happens to everyone at some point, understandably (we are human, after all), but it becomes a problem when a pattern develops.
Of course, this kind of impulsive spending isn’t the only reason people get into debt. Unavoidable situations and emergencies often require individuals to rely heavily on credit to make ends meet and get by.
Regardless, a debt consolidation loan may only be treating the symptoms of your debt and not the root cause. Sure, a debt consolidation loan could make your current debts easier to manage and more affordable to pay off in the short term. However, it also frees up a ton of previously tied up credit all at once. It’s vital that you resist the temptation to use that newly available credit. Otherwise, you’re just digging a deeper hole.
If you do opt for a debt consolidation loan, you need to be strategic about it. You can’t treat it like a solution for all of your problems with debt… it’s not. It’s a means to an end, the type of thing that gives you a little bit of breathing room to figure things out and come up with a plan to spend more responsibly and introduce some financial stability back into your life. Ceasing to use credit irresponsibly has to be a part of that plan or you’ll just be right back where you started, but worse.
Overall, debt consolidation loans aren’t perfect. However, they can be an incredibly effective way to borrow money to pay off burdensome debts, take control of your finances, and see a light at the end of the tunnel. If you’re curious about your debt consolidation options, check out our reviews and contact National Debt Relief today!