How does debt consolidation work and is it a good idea for you? To make these important financial decisions about your debt, you'll want a deeper understanding of how it all works.
Debt consolidation can be really beneficial in a lot of ways. But that doesn't mean it's going to be the right decision for everyone. There are many ways to help tackle and get out of debt and consolidation is one of many ways.
Whether you should consolidate your debts depends on several factors like what kind of debt you have, how much debt you have, and the consolidation providers you qualify for.
By learning more about debt consolidation and how it works, you can be better prepared to decide if debt consolidation is a good idea for you or not.
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What is Debt Consolidation?
Debt consolidation is a type of debt refinancing that brings multiple debts into one single loan. It is a financial tool and strategy that can help those who have multiple debts.
Instead of managing multiple debts with multiple payment plans and interest rates, consolidating debts into one single debt can make debt repayment easier and more manageable.
Depending on the provider, this method can offer benefits like one monthly payment instead of multiple, a better interest rate than one or several of your individual debts had on their own, an extended payment plan that allows for a longer repayment period, and potentially more manageable minimum payment amounts. This method can also help you avoid things like needing a deferred payment, defaulting on any of your debts, or even bankruptcy.
How Does Debt Consolidation Work
So how does debt consolidation work exactly? The process of how to consolidate debt includes assessing all your debts, researching debt consolidation loans, and combining or consolidating multiple debts into one loan.
Step 1: Assess All Your Debts
The first thing you need to do is assess all of your existing debts. You might do this by making a list of all your sources of debt or even creating a list in a spreadsheet to also outline details about each debt.
Doing this step will help you see an overview of your personal debt situation. This will help you know if consolidating your debts into one debt could be better for you financially, then continuing to make multiple regular debt payments on multiple types of interest.
Step 2: Research Debt Consolidation Loans
Once you’ve assessed your financial situation and determined that consolidation is a good idea for you, it’s time to research loans to consolidate debt. Debt consolidation is essentially a type of loan that is specifically used for the purpose of combining multiple loans into one loan. Research the debt consolidation programs available to you and pick the one that best suits your individual needs.
Step 3: Consolidate Debts into One Loan
If approved for a debt consolidation loan, then you can now consolidate multiple debts into one loan. You may need to pay off debts using the debt consolidation loan, or the debt consolidation loan provider may have a system in place to do that for you.
Now you can pay off debts with just one loan, one interest rate, and one payment to worry about.
How to Consolidate Debt
Once you know what debt consolidation is, how it works, and that it’s a good idea for you, you can start looking into how to consolidate debt. There are several common ways to consolidate debts. You could use a credit card, a personal loan, a home equity loan, or a debt consolidation loan from a lender.
Consolidate Debts with a Credit Card
Some forms of revolving credit, like credit cards, will allow you to transfer multiple credit balances onto your card. This could allow you to consolidate credit card debt into one card instead of several.
If you aren't sure if this is possible with your card, research your credit card online or reach out to a representative with your credit card company.
You'll want to pay attention to things like interest rates and balance transfer fees before you go forward with using a credit card for debt consolidation.
Use a Personal Loan for Debt Consolidation
Some loans will allow you to use a personal loan for debt consolidation to pay off debts so that you can have just one loan debt instead. Personal loans can be a useful choice as a debt consolidation loan because they don’t have to be used for a specific purpose the way some loans need to be.
Compare the interest rates of your current lines of credit with the personal loan you are thinking about using to see what loan would save you the most on interest.
Consolidate Debts with a Home Equity Loan
A home equity loan is a personal loan that uses the value of your home to make this funding a secured loan option. By using the value of your house as collateral you can potentially get better loan terms.
Consolidate Debts with a Debt Consolidation Loan
Still not sure if debt consolidation is a good idea for you? Try talking to the financial institutions you already know and trust. Some lenders offer loans that are expressly designed to consolidate your debt into one account and one payment. A debt consolidation loan is a type of personal loan that lets the borrower use the loan for the purpose of paying off debts from multiple creditors to roll those debts into one.
Some loans that are specifically designed for debts can even come with debt management plans to help customers get their finances in order and avoid more debt in the future.
Is Debt Consolidation a Good Idea for You?
Whether debt consolidation is a good idea for you or not will depend on several factors like the amount of debt you have, the kinds of debt you have, and how you want to consolidate those debts.
For instance, it can depend on your credit score. If your credit score is poor you may only qualify for certain types of debt consolidation loans for bad credit. For instance, you might not qualify for a personal loan, but you might qualify for a home equity loan.
Does Debt Consolidation Hurt Your Credit?
One of the big deciding factors for if a consolidation debt loan is a good idea for you is how it might impact your credit. Loans for debt consolidation are still loans, so the impact you might experience on your credit score will depend on this loan's application process. Some loan applications involve what's called a soft credit inquiry while others involve a hard credit pull.
A soft credit pull won't really affect your credit score, while a hard credit pull will. If you are worried about the effect a loan application might have on your credit, talk to a loan representative first to learn what kind of credit check the loan application performs.
Ultimately, it’s a great idea to consult a professional, like a financial advisor with credit counseling or even a debt consolidation attorney, anytime you need to make a major financial decision like this.