Debt consolidation – See if it’s a good alternative for you

What does debt consolidation mean?

Debt consolidation is an excellent method because it combines all your debts into a single payment.

Among the advantages is the possibility of lower interest rates.

For example, let’s say a person has personal loan debts and 2 credit cards.

In this case, 3 interest rates are applied, and the debt becomes even more expensive.

By consolidating, on the other hand, you only take on one debt to pay off the others and only do so when the interest rates are lower.

As a result, in the long term, you pay less when you use consolidation.

Secondly, the debt is paid off more quickly and by doing so on time, your credit score improves.

Types of debt consolidation

If you want to consolidate your debts, you should know that the main way to do this is through a loan.

But there are different loan options, and we’ll go into the details of each one so that you can decide which is best for you.

Firstly, there is the credit card balance transfer.

Several banks offer balance transfers at low or 0% interest for those who want to consolidate their credit card debts.

In general, we recommend that you pay attention because the promotional interest rate usually lasts for a limited period.

In other words, after the specified time, the debt consolidation rate can go up, as can the payment amount.

So be aware and do your research before you sign up to see if it’s really worth it in your case.

Also, remember that the bank may charge a balance transfer fee.

The fee is usually a certain percentage of the amount transferred or a fixed amount, whichever is higher.

With this method, you should be aware of some risks.

For example, you can’t count on the grace period if you use the same credit card to make new purchases.

You will also have to pay interest until you pay off the entire balance, including the transferred balance.

On the other hand, if you fail to make the payment for more than 60 days, the bank may increase the interest rate on all the balances.

In this sense, we must include the transferred balance.

Debt consolidation loan

As the name suggests, in this modality, several debts are converted into a single loan.

In this case, you have access to an amount equal to the total of your outstanding loans, so that the money can only be used to pay off the debts.

This simplifies the number of payments you make each month.

The main advantage is that the interest rates are lower than those you are currently paying.

But remember again that the bank can apply “teaser rates” which only last for a certain period.

In other words, the amount you pay each month may increase at the end of the period.

Another point to watch out for is this:

Although the monthly payment is lower, you may have to pay off the loan over a longer period through debt consolidation.

This means that, for the time being, you can organize your finances and deal with a smaller monthly debt.

However, when we look at the long term and compare it to your reality without consolidation, the amount you pay in interest is higher.

That’s why it’s important to check the terms of the loan and the interest rates to determine how much you’ll pay in total.

All this should be done before you take out the loan.

Another point you should be aware of is the following:

Approval depends on your credit score, income, debt-to-income ratio (DTI) and more.

Personal loan 

Unlike debt consolidation, the value of a personal loan can be used in any way you prefer.

In this sense, you can pay taxes, make repairs to your home, travel, get married, among others.

In this way, all the loan funds are received in a single payment.

Since most personal loans are unsecured, the interest is based on your credit history, as well as your credit score.

The downside is that there are no standard eligibility requirements.

As a result, each lender has its own specific rules, such as having a high credit score to access lower rates.

There are also different minimum loan amounts.

In other words, you could end up with more funds than you need and if you don’t get a grip, you could face worse debt in the future.

Which is better, personal loan or debt consolidation?

The best loan is the one with the best conditions for you.

Although personal loans aren’t just for consolidation, they can also be used to unify your debts.

We therefore recommend that you contact banks and financial institutions you trust.

In this contact, check which is more advantageous: investing in a consolidation loan or a personal loan.

Ideally, you should analyze the interest rates for both and other details such as terms.

Is it a good idea to consolidate your debt?

Yes, if you have several loans or high-interest debts.

However, it depends on your credit score.

For example, if you have a low score and can’t qualify for a lower interest rate, there’s no point in opting for debt consolidation.

It’s also crucial to think twice if you haven’t solved the underlying problems that led to the current debts.

Let’s assume that a person has fallen into debt due to excessive spending.

If the person enters into the consolidation agreement and continues to use their credit card inconsistently, the consolidation was certainly not a good thing.

In other words, paying off several credit cards with one loan is no excuse for increasing the balances again and having even more financial problems in the future.

So, bear in mind that there are positives and negatives to consolidation, which we’ll go into below:

Pros of debt consolidation

This is an alternative that simplifies your finances.

Concentrating your debts into a single loan reduces your worries.

And if you’re working towards a debt-free lifestyle, through consolidation, you’ll have an idea of when all your debts will be paid off.

Having debts can be nerve-wracking, and it even creates financial anxiety because it seems that the debts will never end.

When you have a deadline for paying off your debts through debt consolidation, it simplifies your finances and gives you better mental health.

Secondly, we should talk about the possibility of making extra payments with the money you save each month.

By doing this, you speed up debt repayment and get out of financial trouble faster.

The big advantage of doing this is that you save on interest when we talk about long-term strategies.

Therefore, during the consolidation period, you can study more about finances, applying strategies such as emotional intelligence in finances.

This allows you to save money and learn how to invest your resources in big financial goals such as buying your dream home.

Finally, know that debt consolidation can improve your credit score.

Although there may be a temporary drop in your score due to the strong credit inquiry at the time you apply for a loan, after this period, by making consistent payments on time, your score improves.

Another interesting point is that:

What are the risks of consolidating debt?

The first risk would be the need to deal with additional costs such as origination fees, balance transfer, closing costs and annual fees.

As a result, you should be aware of the true cost of the operation before signing the contract.

There is also the danger of being charged additional fees if you fail to make your loan payments in a given month.

It is therefore essential that you review your budget to ensure that you can comfortably cover the new payment.

There is no point in getting a debt consolidation that takes up 50% of your income, while your monthly expenses also take up 50%.

In this case, 100% of your salary is used each month, so you don’t have any dollars left over to deal with unforeseen circumstances.

And as well as being careful about the percentage you commit to paying back the loan, take advantage of tools such as automatic payment.

And if you think you might miss a future payment, let your lender know as soon as possible.

Another major risk of consolidation is that it can create the illusion of having more money than you actually do, something that encourages increased spending.

Therefore, when budgeting, as well as analyzing the percentage of your salary you can use to pay off the debt, make sure you organize yourself so that you don’t spend more than you should.

Other risks of debt consolidation

Also, don’t just read one article to be sure about consolidation.

Remember that some types of debt have higher interest rates than others.

Compared to credit card rates, student loan rates are much lower.

Therefore, consolidation could result in a lower rate on some of your debts.

However, remember that the rate may be higher for other debts, which in this case would be the student loan.

As a result, we recommend that you analyze each debt individually before undertaking debt consolidation.

Perhaps if the person has several credit card debts and a student loan, the ideal thing in their case would be to consolidate only the credit card debts.

This would leave them with two low-interest debts: 

That of the student loan and that of the consolidation loan.

Anyway, as we explained a little above, when we look at the long term, you may have to pay more.

This is because the payment period is longer (up to 7 years). 

As a result, you pay an interest rate for a longer period.

In this way, the overall monthly payment may be lower than you’re used to, but the interest will accrue over a longer period.

But all the risks of debt consolidation can be solved when you educate yourself financially.

A person who prioritizes their financial control learns to save and prioritize debt settlement.

In this sense, all the negative points of consolidation are set aside because the person knows how to use the strategy wisely.

Tips

Organization is the key to success, so the first step is to add up the balances of all your debts to find out how much money you need.

For example, let’s say you have debts on 2 credit cards and 1 personal loan.

The debts are as follows:

• Card 1 – $2500;
• Card 2 – $3670;
• Loan – $5907.

$12,077 is the total value of the debts, but remember the following:

By paying for the debts upfront, you can check for discounts, so let’s assume the following:

With full payment of the debt on card 1, the bank only charges $1500.

On card 2, the debt becomes $2500 and on the loan, $4500.

So, instead of asking for $12,077, you only need $8500 to pay off all your debts through debt consolidation.

Secondly, analyze your finances to determine how much you can put aside each month to get rid of your debts.

Let’s assume that your salary is $2000 and your total monthly expenses are $1000.

Don’t commit a large percentage of your income

Normally, the maximum percentage indicated for committing income to a loan is 30%.

In this case, $600 can be used for consolidation.

Note that although you have $1000 available, it is not recommended that you sign a contract with installments of this amount, since it corresponds to 50% of your monthly income.

With your emergency fund, you can apply $1000 a month to pay off your debts, but it would work as follows:

You would agree to monthly installments of $600 for the debt consolidation and use $400 for the extra installment payments.

As a result, you will get good discounts and be able to pay off the debt more quickly.

At the same time, in a month when you have to deal with an unforeseen financial problem and the emergency fund isn’t enough, you’ll have $400 to deal with the situation and $600 to pay normally for the loan.

Also, think about whether it would be advantageous in your case to take out a loan with a shorter repayment period.

In this sense, you will have less time to pay back the loan.

Which means that the monthly payments will be higher.

Despite this, interest is lower.

But you can also opt for a loan with a longer repayment period.

As a result, the monthly payments are lower, but the long-term interest rates are higher.

Direct payment to creditors and automatic

When you opt for a debt consolidation loan instead of a personal loan, the payment is made directly to the creditors.

This ensures great ease during the process because you don’t have to contact different banks to settle the debts.

In other words, you don’t have to deal with the debts individually.

It’s also interesting because it prevents you from using the money for other purposes.

Imagine that an individual has applied for a personal loan to consolidate their debts.

But their car breaks down on the day the funds are deposited in their bank account.

In a moment of urgency, this individual decides to use the money to fix the car.

But, as you can see, this leads to more debt.

In the case of a debt consolidation loan, you will need to provide the lender with the details of the creditors you owe.

You also indicate the exact amount that each creditor should receive, so that payment is made directly, and any problems are avoided.

And even though it’s obvious, we recommend again that you opt for automatic payment of installments.

Otherwise, it could burden you with late payment penalties and lower your credit score.

What’s more, you don’t need to put more weight on your memory than necessary.

Consider that you already have dozens of bills to pay, such as:

Your child’s school fees, water bill, rent, credit card bill.

As well as making your life easier, this also gives you access to a small discount.

LightStream, for example, offers borrowers a 0.50% discount on the rate when they opt for automatic payment.

Stop increasing debt while paying for debt consolidation

Finally, we must remember:

Consolidation can give false hope of extra money.

Your payments will seem more manageable, and you will feel less stressed. 

At this point, you may be tempted to buy dream products and use your card uncontrollably.

Don’t do this, as you’ll just create a new source of debt that you’ll eventually have to pay off.

Of course, you don’t have to get rid of your credit card after debt consolidation.

But an interesting tip would be to use it as a debit card.

In other words, you only buy with your credit card when you have money in your bank account to cover the purchase.

Otherwise, you have to wait.

Daniel 25 de March de 2024