Managing all of your debt, with multiple due dates, interest rates, and minimum payment amounts, can be a difficult task to follow. Missing a payment can hurt your credit rating and your chances of borrowing money in the future.
That’s why consolidating all of your monthly bills into one payment with a new personal debt consolidation loan can be a great way to simplify your financial life, keep your credit strong, and make it easier to pay off what you owe. each month. Of course, you need to keep paying all of your bills on time until you’ve made it easier to set up payments with your new loan.
What is a personal loan for debt consolidation?
Using a personal loan to consolidate debt involves paying off all of your credit cards, loans, and other debts with the loan funds and then making a manageable payment for your personal loan until it is paid off. .
If you have more than one type of debt, a personal loan can help you keep it up to date. Falling behind on one of your payments, whether it’s a credit card or a student loan, can crush your credit score. It could also hurt your chances of borrowing money in the future.
Debt Consolidation Loan vs Personal Loan
Although it is often referred to by its own name, a debt consolidation loan is simply a personal loan used to consolidate debt.
A personal loan is a sum of money that can be used for a variety of purposes, such as making a large purchase. You repay the loan in monthly installments for a specified period. Personal loans are generally unsecured which means that they don’t have any collateral backing them up.
Benefits of consolidating debt with a personal loan
Debt consolidation with a personal loan has several advantages that make it an attractive option:
- A monthly payment: It can be difficult to keep up with multiple monthly debt payments. A debt consolidation loan simplifies your finances and allows you to make a single monthly payment.
- Lower interest rates: Although personal loans often have higher rates than secured debt, they can have lower rates than credit cards.
- Pay off your debts faster: With a lower interest rate, you may be able to save money and pay off your debts sooner with a personal loan.
- Improve Your Credit Score: Using a personal loan to consolidate debt can improve your credit score by increasing your available credit, which in turn lowers your credit utilization rate.
Disadvantages of consolidating debt with a personal loan
While a debt consolidation loan has its advantages, there are also disadvantages that you should consider:
- Potentially high interest rates: Personal loans generally have lower interest rates than credit cards, but for borrowers with poor credit, personal loan rates can exceed 30%.
- Additional upfront costs: When you take out a personal loan, you may be subject to loan origination fees. Other ongoing charges may include prepayment penalties and late payment fees.
- Could encourage more spending: Debt consolidation does not solve the fundamental problem of why you got into debt. If you consolidate your credit card debt with a personal loan, you might be encouraged to start accumulating new debt.
When should you take out a personal loan to consolidate your debts?
Having high interest debt, like credit card debt, could make you a good candidate for a debt consolidation loan because personal loans tend to have lower interest rates than credit cards. . You might be a good candidate for a personal loan if:
- You have strong credit: The better your credit, the more likely you are to qualify for a loan at the lowest interest rate. The lower your interest rate, the less you have to pay on top of the money you borrow.
- You have significant, but controlled debt: If you have a large debt load, but you are able to make at least minimal monthly payments, a personal loan may be the best fit for you.
- Your expenses are under control: A personal loan won’t help you if you don’t get your spending under control. In fact, it could put you in even more debt. Before getting a personal loan, take a look at your finances to make sure you can afford the loan and pay off your debt.
You can still qualify for a personal loan if you don’t have good credit, but you might face higher interest rates. If your personal loan rates are higher than what you are currently paying on your debt, try other ways to settle your debt. Once your credit improves, you may be eligible for lower interest rates on debt consolidation loans.
Other ways to consolidate debt
If a personal debt consolidation loan isn’t working for you, there are several ways you can consolidate debt, including:
Home equity loan
If you own your home and owe less on your mortgage than the home’s value, you may be able to take out a home equity loan and use it to pay off your outstanding debt. A home equity loan is a type of second mortgage that allows you to borrow against the equity in your home. You can use the lump sum you receive from your home equity loan to pay off all of your unpaid debts, then make just one payment on the new loan each month.
For home equity loans, your home is secured. As a result, the lender considers your loan to be less risky, which means that the interest rates are generally lower than unsecured loans such as personal loans. But keep in mind that if you fall behind or fail to make your home equity loan payments, you could lose your home. Calculate your home equity to see if you qualify to borrow enough to cover your outstanding debts.
Balance Transfer Credit Cards
If you want to manage a few credit card balances, you can try a credit card with balance transfer. Many cards offer 0% APR for a fixed term, typically ranging from 12 to 21 months.
It’s a good way to transfer all of your existing credit card debt into one manageable payment each month. Keep in mind that if you have a lot of credit card debt, you might not be approved for a balance transfer for the full amount you need to transfer. This means that you could pay off your new card balance as well as any cards that could not be transferred.
If you don’t pay a balance transfer credit card before the end of the 0% APR period, the card issuer starts charging interest.
Debt Payment Strategies
If you don’t qualify for a new loan or credit card transfer, you may need to manage your debt in a different way. If you haven’t already, start by organizing your debt on a spreadsheet. Write down each lender you owe money to, your current interest rate, how much you owe, and your monthly due date. From there, you can try out several debt management methods:
- Debt snowball: This method focuses on paying off your smallest debt first. While making minimum payments on any other debt you have, you are spending all of your extra money on the debt with the lowest balance. Once that’s paid off, you then focus on investing all of your extra money towards the lower balance. Do this until all of your debts are paid in full. The advantage is that you will see results quickly. The downside is that you could end up paying more interest on other debts that charge higher rates.
- Debt avalanche: This method focuses on paying off the debt with the highest interest rate first. You make minimum payments on all of your other debts and then spend all of your extra money on the debt with the highest interest rate. Do this until the debt is paid off, then switch to the debt with the highest interest rate until all of your debt is paid off. While you can save more money by paying off higher interest rate debt first, you might not see results as quickly as with the snowball method.
The bottom line
A personal loan can be a great way to consolidate debt, but it’s not necessarily the right method for everyone. Review your debt situation and see if a personal loan would work the best. Otherwise, try methods like a home equity loan or balance transfer or debt management strategy.