The New York Federal Reserve reported that U.S. consumer debt, including home loans, car loans, credit cards, and college loans, peaked at the all-time high of $16.51 trillion during the third quarter of 2022.
Americans have been motivated to come up with solutions for managing their growing credit card balances after a 2.2 percent increase which equates to $351 billion since the second quarter of 2022.
Some people think about getting a debt consolidation loan as a potential solution.
Debt consolidation involves taking out one new loan to pay off multiple smaller debts, with the goal of lowering interest rates and simplifying payments.
However, like any financial decision, there are both pros and cons associated with debt consolidation.
In this article, we’ll look at the advantages and disadvantages of a credit consolidation loan so you can decide if it’s suitable for you.
How debt consolidation works
Consolidating debt means rolling multiple debts into one loan with a lower interest rate. This is often done with high-interest credit card debt, car loans, student loans, medical bills or other types of loans.
Through debt consolidation, you only need to make one payment a month to a single lender who will take care of all your outstanding debts.
By consolidating debt, you’re able to take out a loan, such as a personal loan or a home equity loan, and use the funds to pay off existing creditors.
Eliminating multiple debts by paying them off leaves you with a single loan and a predictable monthly payment. This makes it easier to stay on top of your finances since you don’t need to keep track of multiple payments due each month.
Debt consolidation has many advantages, such as the ability to obtain more favorable loan terms than what you currently have. For instance, if your credit cards come with high-interest debt, you might be able to get a consolidation loan with a lower interest rate.
This may drastically reduce the amount of interest you pay throughout the life of the loan.
Debt consolidation makes it easier to pay off your debts and can even help you do it quicker. With multiple debts, it can be hard to keep track of the payments you’ve already made and the ones that still need to be paid.
A consolidation loan offers only one single payment per month and you’ll be able to determine when your debt will be completely paid off. This can help to keep you motivated and focused on paying it off.
Before taking out a debt consolidation loan, be sure to check the qualifications and fees involved, as well as read through the terms and conditions carefully.
Taking out a debt consolidation loan does not erase your debt, it just moves it to another loan, so you still have to pay it off.
Debt consolidation can be a beneficial option to help you pay off high interest debts, organize your finances and become debt free sooner.
Before agreeing to a new loan, you should weigh the pros and cons thoughtfully and ensure that you understand all details of the agreement.
Pros of debt consolidation
Here are the Pros of Debt Consolidation.
Faster debt repayment
Debt consolidation can aid in paying off debt more quickly. By combining multiple debts into a single payment, you have clarity on when the loan will be repaid and an easy-to-manage single payment. This can help you stay disciplined and motivated to get out of debt.
Consolidating debt can make managing your finances easier. When you have multiple debts, it can be hard to remember which ones are paid off and which still need to be dealt with.
A debt consolidation loan lets you make one payment each month and budget accordingly, decreasing the amount of stress usually incurred when managing numerous debts.
Lower interest rates
Getting a consolidation loan can provide you with more beneficial loan terms than what you have now. For instance, if you owe money on high-interest credit cards, you could possibly obtain a consolidation loan that has a much lower interest rate.
This can save you a significant amount of money in interest charges over the life of the loan.
Fixed repayment schedule
With a fixed repayment plan, the amount you pay for your loan won’t change and you’ll know exactly what your monthly payments will be. This makes it easier to budget and plan ahead.
Improved credit scores
Taking out a debt consolidation loan can cause a temporary drop in credit score due to the hard inquiry, but will likely lead to an increase in the long run.
This will help you make payments on time, which is important because payment history makes up 35% of your credit score. Making timely payments will boost your rating.
Prior to making a decision about debt consolidation, it’s important to look at your current financial state and future objectives. Keep in mind that this solution may not be the best fit for everyone.
When consolidating debt, you’re transferring the debt to a different loan instead of erasing it, and you may still need to pay it off.
Cons of debt consolidation
Here are the Cons of Debt Consolidation.
When consolidating your debt, you may be charged fees such as application, origination, and prepayment penalties.
When you add up the costs, consolidating your debt can be more pricey than making payments on your current loans.
Risk of accumulating more debt
Combining your debt might give you a false feeling of financial security. When you consolidate your debt, you may be more likely to incur additional debts due to the larger amount of available credit. This can result in further financial problems down the road.
Impact on credit score
A credit check may be necessary when consolidating debt, which could have a negative effect on your credit score. Applying for a consolidation loan may result in a hard inquiry on your credit report, causing your score to drop by a few points.
Also, if your credit utilization rate is high, that is the proportion of offered credit you are using, consolidating your debt can raise your rate and negatively affect your credit score.
Limited debt relief
Debt consolidation may make managing finances easier, but it won’t necessarily decrease your overall debt. The amount of debt you owe will remain the same and you’ll still need to repay it.
If your consolidation loan has a higher interest rate than your existing loans, you may end up spending more in the long term.
Not every kind of debt can be consolidated; student loans backed by the government and tax debts are two examples of ineligible debt.
In addition, not all financial institutions provide debt consolidation loans, and the terms of these loans can differ.
When considering debt consolidation, it’s important to take into account your current finances and future aspirations before determining if this is the right choice for you.
Debt consolidation doesn’t erase your debt, it just transfers it to another loan, and you may still have to pay it off. Getting advice from a financial advisor or credit counselor is a good idea so you can choose the best course of action.
All in all, debt consolidation can help with high-interest debt, organizing finances, and liberating from debt more quickly.
Carefully review the advantages and disadvantages before making a decision on the loan and be sure to comprehend all of its terms.
Debt consolidation has several benefits, such as consolidating multiple debts into one payment plan with an interest rate lower than the original debts, simplified finances, a fixed repayment schedule and potentially boosting your credit score.
However, debt consolidation can have many drawbacks– such as fees charged upfront, the potential to accumulate more debt, a negative impact on your credit score, limited financial relief and a limited number of options.
It’s important to remember that debt consolidation may not be suitable for everyone and it’s important to carefully consider your current financial situation and future goals before making a decision.
Consolidating your debt doesn’t mean that it goes away; you may be transferring the debt to a different loan and still have to pay off the balance.
It’s advisable to get advice from a financial expert or a credit counselor who can review your choices and help you make the right decision.