With consumer debt rising, a lot of people are struggling to keep up with credit cards and loan repayments. Debt consolidation is one option, but it’s important to consider the pros and cons.
Here’s how debt consolidation works and who should use it:
What is debt consolidation?
Debt consolidation works by taking multiple debts, such as loans and credit cards, and combining them into a single loan. This usually has a lower interest rate.
It’s usually used to reduce debts by switching to a lower interest rate. It can also be a way to reorganize finances and make a monthly budget more affordable.
Types of debt consolidation
There are two main types of debt consolidation:
- 0% balance transfer credit card: This allows consumers to transfer their debts onto one balance transfer card and pay it off during the 0% promotional period.
- Debt consolidation loan: A debt consolidation personal loan or home equity loan can be used to pay off the debt in loan installments over a fixed term.
The advantages of debt consolidation
Here are some of the advantages of consolidating debts:
1. Credit score improvements
One benefit of debt consolidation is that it can increase credit scores. One study shows that those who consolidated at least $5,000 in credit card debt found their credit scores rose an average of 38 points in as little as a month.
2. Streamlining finances
For consumers that have multiple payments and interest rates to worry about, consolidation can streamline this and combine all their debts into a single payment that’s easier to manage.
This can reduce the risk of late or missing payments, and it also gives a clearer idea of when the debt will be paid off entirely.
3. Lower interest rates
The main appeal of debt consolidation is that it can mean lower interest rates. This can either reduce the monthly payments or the overall time it takes to pay the debts off.
Putting several debts into a single personal loan can mean getting a rate that’s lower than some of your debts but higher than others, so it’s important to check carefully.
The disadvantages of debt consolidation
Here are some of the disadvantages to consider:
1. There might be better alternatives available
Before taking out a new loan or credit card, it’s essential to check for a better alternative, first. For example, using savings is usually the best option for clearing debts.
Also, consolidation isn’t always cost-effective. It can sometimes increase the amount you owe due to additional fees, so borrowers should always check this in advance.
2. Harder to get with bad credit
Debt consolidation loans are open to people with bad credit, but there may be fewer lenders you can borrow from and the interest rates can be higher.
3. Can encourage extra spending
If the debts have built up due to poor budgeting, one risk of consolidation is that it will encourage more spending and it’s easy to fall back into debt.
It’s important to make an effective budget to reduce spending and stay on top of payments so you don’t end up with more debt than you started with.