As Americans’ debt keeps growing, many are looking for creative ways to get out of it. According to the Federal Reserve Bank of New York, consumer debt, including credit card debt, student loan debt, and auto loan debt, reached record highs in the second quarter of 2022. This increased debt can be overwhelming for many people, so finding ways to pay it off is essential.
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People often use debt consolidation to lower their monthly payments and make their financial lives easier. When you consolidate debt, you combine all your outstanding debts into one loan with one monthly payment. This can be a great way to save money on interest and get out of debt faster.
There are a few things to consider before consolidating debt, however. First, you need to make sure that consolidating your debts will save you money.
Debt consolidation: how does it work?
Debt consolidation can be a great way to save money and get your finances in order. By taking out one loan to pay off multiple debts, you can often get a lower interest rate and save on monthly payments. There are several ways to consolidate your loans, including personal loans, home equity loans, and HELOCs. Choose the option that best suits your needs and budget to get started on the path to financial freedom.
No matter what type of loan you choose, you’ll follow a similar process to get started. You’ll compare interest rates from different lenders to find a good deal, and then apply for a loan that will cover your existing debts. Once you get your loan funds, you can pay off your debt and start making payments on your new loan.
Example
Assuming you owe money on the following, Bankrate’s debt consolidation calculator can help you see what your options are. Having several debts can be hard, but putting them all into one loan may make your monthly payments easier.
- Credit card #1: $5,000 balance, 15.9% interest rate, $141 monthly payment
- Credit card #2: $7,500 balance, 17.9% interest rate, $220 monthly payment
- Credit card #3: $10,000 balance, 19.9% interest rate, $304 monthly payment
- Auto loan: $12,500 balance, 6% interest rate, $350 monthly payment
- Personal loan: $4,000 balance, 11% interest rate, $250 monthly payment
Would you like to save over $5,000 in interest and lower your monthly payments by almost $300? A 48-month debt consolidation loan with an interest rate of 7.5 percent can help you do just that.
Consolidating debt can hurt your credit
Debt consolidation loans may not be the best option for everyone. Although they can help lower your monthly payments, they can also hurt your credit score. When you ask for a loan, the lender will check your credit, which could lead to a hard inquiry. This could lower your credit score by 10 points. Hard inquiries will only affect your credit score for one year.
While consolidating credit card balances can help improve one’s financial situation, it is important to be aware that closing accounts after doing so can negatively impact one’s credit score. This is because the average age of one’s credit accounts makes up 15 percent of a credit score, and longer credit history is generally seen as being more favorable. Therefore, even though you may not use them regularly, it is best to keep old credit cards open rather than close them.
Debt consolidation can help improve your credit score over time, by making on-time payments and improving your credit mix. Payment history is 35 percent of your credit score, so timely payments will help boost your score. Adding a personal loan to consolidate debt can also help improve your credit score, by increasing the variety of types of credit you have.
Your credit utilization is a significant factor in your credit score. By consolidating your debt, you can reduce your credit utilization and improve your score.
Divide your current card balance by your total credit limit to figure out your credit utilization. A high credit utilization ratio can negatively impact your score. But if you pay off your balance with a personal loan, your credit utilization will go down and your score will go up.
Debt consolidation when it makes sense
Debt consolidation is often pursued to save money on interest payments. By consolidating your debt and getting a lower interest rate, you might be able to save hundreds or even thousands of dollars on interest payments.
Debt consolidation is a popular option for people who want to simplify their monthly payments. By consolidating your debt, you can make one monthly payment instead of multiple payments with different due dates. This can make it easier to manage your finances and stay on top of your bills.
How to consolidate your debt smartly
Debt consolidation can be a great way to save money on interest and reduce your monthly payments. To get started, make a list of all your current loans and credit cards, including balances, interest rates, minimum payments, and remaining payments.
See If You Qualify for Credit Card Relief
See how much you can save every month — plus get an estimate of time savings and total savings — with your very own personalized plan.
Then, decide which type of debt consolidation you want: a personal loan, a home equity loan, or a balance transfer credit card. Get quotes from multiple lenders and compare APRs, terms, and total interest paid.
Apply for these loans and credit cards within two weeks if you don’t want your credit report to show a lot of hard inquiries. Once you have all your offers, use a debt consolidation calculator to see which lender is best for you.
The 3 best alternatives to debt consolidation
Debt elimination can seem like a daunting task, but there are a few alternatives you can consider that may help you achieve your goal without taking out a debt consolidation loan.
- Debt Management Plan: There are many benefits to working with a credit counseling agency. They can help you negotiate more favorable terms with your creditors and make one monthly payment instead of multiple charges to different lenders. This can save you a lot of time and money. Credit counseling agencies are usually nonprofit organizations, so you can ensure they have your best interests at heart.
- Credit Card Balance Transfer: Several balance transfer credit cards come with a balance transfer fee of 2 to 5 percent. However, the cost savings are still likely greater than taking out a personal loan. Therefore, transferring your balance to one of these cards may be a smart financial decision.
- Budget overhaul: Keep track of your spending and find ways to cut back on unnecessary expenses. Allocate any extra money you have towards paying off your debts. Search for ways to earn more money and put that towards your debt as well.
The bottom line
Debt consolidation loans can be an effective way to pay down your debt. By consolidating your debt into one loan, you can often get lower interest rates and save money on monthly payments. However, it is important to create and stick to a plan to avoid hurting your credit score.
There are a few different options you can choose from when you’re trying to consolidate your debt. A debt consolidation loan is one choice, but you might also be able to create a debt management plan, take advantage of a credit card balance transfer, or change your budget.
