Debt consolidation plans allow you to take debts from multiple accounts and roll them into a single account that hopefully has a lower interest rate. The result of consolidating your debt is that you will have a single payment rather than multiple bills and all of your debt will have the same interest rate. There are several ways to consolidate your debt, some of which are more beneficial than others.
Debt consolidation is oftentimes a smart choice, but it is important to be aware this debt repayment option is not right for everyone. For one thing, it may be risky to consolidate your debt, especially when using certain methods. This option can also be risky if you have trouble managing your debt in general because it may not have any impact on eliminating debt more quickly. Below, learn about the different methods for consolidating debt and find other important information that will help you decide whether consolidation is a smart move for you.
How does debt consolidation work?
The main purpose of debt consolidation is to make it faster and easier to pay off your debt. When you consolidate debts, you can oftentimes have a lower monthly payment amount. Furthermore, consolidating allows you to choose a repayment plan with a lower interest rate than your current accounts, which means you will end up paying a lower amount overall by the time your debt is paid off. Not only that, having one due date for your payment is easier to remember and will simplify your finances.
However, it is important to understand how debt consolidation works and to learn how it affects your credit. When you consolidate your debts, you essentially close or settle all of your existing accounts and end up putting all of your debt into a single account that you will make payments on until the debt is cleared. By closing any of your existing credit accounts, you may end up shortening the length of your credit history, which can have a negative impact on your score. To avoid damaging your credit score, it may be a good idea to keep longstanding credit accounts open and simply not charge new debts to them in the future.
It is also important to note that paying off your debt will have a positive effect on your credit score because you can reduce your ratio of debt to available credit. Over time, you will see a boost in your credit score as long as you continue to keep a lower amount of debt in the future.
Discover Which Methods to Use for Consolidating Your Debt
Provided that you keep your consolidated credit account in good standing by making payments on time and limiting the amount of new debt you acquire, it is oftentimes beneficial to use debt consolidation. There are several ways to transfer multiple debts into a single balance. The two main methods include:
- Applying for a fixed-rate personal loan. With this method, you can take out a personal loan from a creditor such as a bank that will cover the balance of your existing debts. With the multiple credit accounts paid in full, you will only have to repay the balance of your personal loan, which will ideally have a lower interest rate.
- Using a balance transfer. Do your research to find a credit card with a zero percent interest rate, which may be offered during a promotion for new customers. It is crucial that the interest rate promotion applies to balance transfers, not simply new purchases. Then, transfer your existing debt to your new credit account and make sure you can pay off the balance before the zero percent interest rate promotion ends.
Riskier methods for consolidating your debt include taking a loan out of your retirement plan or borrowing against your home equity. Be aware that either of these tactics could put your home or retirement plan in jeopardy if you are not careful. It is a good idea to talk to a financial advisor before going down one of these paths.
When is debt consolidation a bad idea?
While it might sound great to consolidate multiple debts into a single plan, this option might not always be a good idea. For example, if you are unable to control your spending or you struggle to repay debts, consolidating is only a temporary solution and will likely have no positive impact on your credit. You should also avoid debt consolidation if you do not have enough income to make payments on your consolidated credit account, as slipping into default will have a negative impact.
Lastly, debt consolidation is probably not advisable if you have a low enough amount of debt that you can reasonably pay it off in a year or less. If you are already managing your debt this well, simply keep making payments on your existing accounts as you are already doing.
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