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Last Updated 13.09.2022
Last Updated 13.09.2022

Is Debt Consolidation Loan the Right Loan for Paying Off Your Debt?

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Debt Consolidation

Debt consolidation is a money management strategy that helps consumers get out of debt fast by merging several loans into one. By taking out a consolidation loan, consumers can repay their existing debts fast and save money on interest, as debt consolidation companies usually provide loans with lower interest rates. However, before applying for a consolidation loan, you should consider its positive and negative aspects and decide whether it benefits you. For example, it might not be your best option if your credit score is low. 

What is a Debt Consolidation Loan?

The simplest way to answer the question, “What is a debt consolidation loan?” is to say that it’s a type of personal loan used for refinancing your debt. The loan is suitable for people who have multiple loans that are difficult to manage and make timely payments on. The debt consolidation loan combines separate monthly payments into a single amount that is easier to pay. Moreover, this strategy can help pay off the debt faster by decreasing the interest rates on the total loan.

The debt consolidation loan can merge auto loans, credit cards, medical debts, payday loans, and law school student loans. Unfortunately, there is a misunderstanding that debt consolidation discharges the debts. So no, this strategy doesn’t cancel your separate loans but helps manage everything in one payment and save hundreds or thousands of dollars in interest. 

How Does Debt Loan Consolidation Help You Pay Off Your Existing Debt?

Now that you have the answer to “What is debt consolidation?”, it’s time to learn how this loan works. Debt consolidation loans are usually installment loans with fixed interest rates. It means that their interest rates don’t change over time, and borrowers can calculate the repayment amount every month. 

The main function of debt consolidation services is to combine several loans with different interest rates and repayment schedules and make a single monthly payment instead of several. Let’s say you have three credit cards:

  1. Card 1 – $2,000 balance with an APR of 20%
  2. Card 2 – $5,000 balance with an APR of 25%
  3. Card 3 – $1,000 balance with an APR of 15%

To pay off these balances within 12 months, you must calculate the monthly payment amount for each credit card. But if you combine them into one $8,000 loan with a 10% annual interest rate, you can save on interest. 

Cases When Getting a Debt Consolidation Loan is a Good Idea

You should consider debt consolidation programs in the following cases:

  • To get debt consolidation loans with good terms, you need to have a good credit score. Otherwise, it’s meaningless as the loan will include high interest rates and grow your debt instead of decreasing it. According to the FICO scoreboard, a good credit score starts at 670. 
  • The consolidation of debt is a good idea if your separate loans have high interest rates. For example, the average interest rate on credit cards is 16%. Meanwhile, what’s the best personal loan rate? It’s 9.41%, which is 1.7 times less than the rates of credit cards. Consolidating your debt would help you pay lower interest charges and save money. 
  • Credit cards don’t have a repayment schedule that allows consumers to borrow and pay off the debt on the go. If consumers pay small amounts every month, their debt will grow. On the other hand, the best debt consolidation loans have set repayment schedules and fixed monthly amounts. They are a good choice if you want to have a repayment plan to follow. 

While there are clear benefits to consolidating debt, there are some situations when it isn’t worth doing. For example, getting a debt consolidation loan with a fair or poor credit score isn’t recommended. Your loan may be approved, but the interest rates will be much higher, increasing your costs and making monthly payments unaffordable. Having small debt is the second situation when debt consolidation isn’t recommended. For example, if you have credit union bad credit loans and can pay them off within 6-12 months, it may not be worth getting a consolidation loan. 

Debt Consolidation Loan vs. Payday Consolidation Loan

The best debt consolidation loans and payday consolidation loans are designed to combine several loans for easier management and faster repayment. Unlike debt consolidation loans, the average repayment period for payday consolidation loans is one month. Because payday loans are short-term borrowings, consumers should pay them off within 14–30 days. But since consumers can extend the repayment period, it can take months to pay off the loans. So, shifting your multiple payday loans to a consolidation one can put an end to your debt.

So, debt consolidation and payday consolidation loans have quite a few similarities. Both help consumers pay off their debts faster and save money since consolidation loans typically have lower interest rates than separate loans.

Does Debt Loan Consolidation Affect the Credit Score?

Does Debt Loan Consolidation Affect the Credit Score?

Debt consolidation can affect your credit score in both positive and negative ways. Let’s discuss several cases:

  1. If you have a credit card, you should keep the credit utilization ratio below 30% to maintain a good credit score. For example, if your credit card’s limit is $5,000 and you have a $2,500 balance on your card, the utilization ratio is 50%, which exceeds the maximum allowed rate. Such a high utilization rate can surely hurt your credit score, but there is a solution. When you get a consolidation loan and use it to pay off your credit card, the utilization ratio drops to 0%, and your credit score doesn’t suffer. 
  2. If your credit score has dropped because you have multiple loans and often miss the repayment date, combining your separate payments into one can help you improve your credit score.
  3. The average age of credit accounts has a big impact on your creditworthiness. So, every time you open a new credit account, it negatively affects your credit history. 
  4. Every time the lender conducts a hard credit check to view your credit history, it reduces your score by a few points. For example, when you apply for payday loans with savings account and the loan provider runs a credit check, you lose five points. 

What Steps to Take to Consolidate the Debt

Now, let’s discuss how to consolidate debt. First, you should identify the loans, credit cards, and overdraft debts you want to consolidate. Next, calculate the total amount of these loans with all charges and interest. Now you know how much money you need to cover your existing debt.

Next, take some time to research and select the best debt consolidation companies. Ensure they provide favorable terms and a flexible repayment schedule, and then apply for a consolidation loan. Once your loan has been approved and you receive the funds, use them to pay off your existing debts. Then, you need to repay the consolidation loan according to the repayment plan. You should stick to your repayment schedule to improve your credit score and repay the loan faster. 

FAQ

Can I Use Personal Loans for Debt Consolidation?

Yes, consumers can take out a personal loans to consolidate their debts. Usually, personal loans have lower interest rates than credit cards or payday loans, so it’s more beneficial to take out a personal loan and consolidate existing debts.

How Do I Get a Debt Consolidation Loan?

To get a debt consolidation loan, you should check your credit score first and make sure it’s good enough. Then, list your debts and calculate the amount that should be consolidated. The third step is finding a reliable loan provider and applying for a consolidation loan.

What Does Debt Consolidation Do to Your Credit Score?

Debt consolidation loans can either improve or decrease the borrower’s credit score. For example, if the lender conducts a hard credit check to approve the loan, it will decrease the credit score by five points. On the other hand, the borrower can improve his credit score by making timely payments.

Can Emergency Loans for Bad Credit Be Consolidated?

If you have emergency loans for bad credit, your credit score is poor. In that case, taking out a debt consolidation loan isn’t a good idea.

Which Type of Loan Can be Used for Debt Consolidation?

Consumers can use home equity loans and secured or unsecured personal loans for debt consolidation.