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When is Debt Consolidation a Good or Bad Idea?

If you are like many people on the verge of bankruptcy, you likely wish to know more about debt consolidation and how it will affect your credit. The simple answer is, debt consolidation can be good and bad depending on both your financial situation and the type of debt consolidation you are considering.

Debt consolidation could minimize your monthly payments and offer near term relief. However, an extended-term could translate to paying a higher amount of total interest. Consolidating a loan involves combining several loans into a single payment. It is a great idea when your debt is not excessive, and you’ve got good credit and well thought out plant to clear the debt.

How debt consolidation works

Dealing with multiple creditors is perhaps one of the toughest situations you can find yourself in when you are in debt. In addition to having too many accounts to monitor, there’s a pile of monthly bills on your desk, a family to fend for, and other expenses to take care of. And if you delay payments, your phone won’t stop ringing. It’s a tight spot. If you are caught up in such a situation, consolidating your debt may come in handy. But the question is, how does it work, and how do you go about it?

You have two options when it comes to debt consolidation: debt consolidation programs and taking out a loan. Debt consolidation with a loan involves you taking a sizable loan and using the funds to clear your debts. Then, you can focus on clearing the new loan through monthly payments. You can get this loan through your bank, home equity loan, or debt relief companies. Debt consolidation programs, on the other hand, allows you to consolidate unsecured loans without the need to borrow more money. In this case, the debt relief company you are working with will devise a plan together with your creditor, so that you can pay a single consolidated payment to the firm, as they pay your creditor.

When should you consider debt consolidation? 

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You can utilize the proceeds from debt consolidation loans to offset all other loans. By consolidating your debt into one, you get to reap these three benefits:

Lower interest rates

One of the best things about consolidating your debt is that you can save a lot of money on a lower interest rate. Reducing your interest rate translates to more money going to clear the principal balance as opposed to interest. This can take years off debt repayment and help you grow financially going forward. And since your debts will be cleared sooner than if the interest rates were intact, you’ll enjoy significant savings.

A higher credit score

With so much debt on your back, you have likely exhausted all your credit cards (your utilization rate will be skyrocketing). Unfortunately, this ratio can affect your credit score negatively. By offsetting the credit cards with a consolidation loan, you get to lower your cards’ utilization. A study published in Forbes revealed that those who used a loan to clear credit cards had an average of 21 point increase on their credit scores within three months of payment. Clearing your credit card loan fully is the best way to increase your credit score.

An easier way to pay

It might be challenging to keep track of all the accounts if you owe multiple creditors. With so much to take care of, it’s easy to feel overwhelmed. But with debt consolidation, you are able, to sum up, all the credit cards loan into one and only monitor a single account. But a word of caution, you should always consider the APR – it is not a great idea to pay higher interest rates just because of the convenience that consolidation presents.

Risk of consolidation 

Charging up more debt

If you are working to clear your credit card debt only to load them up again, then it will be of no use. Doing that will only render loan consolidation the worst financial mistake of your life.

Loan associated fee

Look at the charges associated with the loan, including early repayment fees. Financial institutions expect you to pay the credit within a specific time. If you clear the balance early, they won’t make a profit. So they may charge you for early repayment.

Collateral 

Some financial institutions will need collateral for the loan. Should you default on payments, you may end up losing the collateral.

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