A Simple Guide to Debt Consolidation

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Published by GreenSprout Experts | 10/28/22

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Being under a mountain of multiple debts can seem like an impossible obstacle to tackle. Thanks to debt consolidation, however, there are options you can use to make this battle more manageable. Read on to learn more.

What Is Debt Consolidation?

To put it simply, debt consolidation takes multiple debts you owe payments on and wraps them up into a single debt. For example, if you have multiple credit cards and other typically high-interest types of debt that each have different amounts and interest rates, you can consolidate them all into one debt with one rate and one payment. This can be an incredibly helpful option for borrowers who are able to repay their debts but would like to simplify their repayments and/or attain a better interest rate on multiple debts at once.

What Types of Debt Consolidation Are Available?

There is more than one way to consolidate debt, but generally, the following 2 ways are the most common:

0% interest credit card: There are various credit cards that offer a 0% interest with balance transfer. This type of card is ideal for debt consolidation because it allows you to transfer your outstanding balances from other higher-interest debts into a single card with 0% interest. Not all cards allow balance transfers, so be sure to check before applying. However, there are 2 things you should know. First, you'll most likely need a good or excellent credit score (690 or better) to qualify for this type of card, and second, these cards are to be used for a promotional period of time, so pay close attention and pay off your debt before the 0% period ends. If you can do that, you'll save yourself a bundle.

Debt consolidation loan: Just like any other type of loan, the better your score is, the better the rate of a debt consolidation loan will be. With this loan type, you can generally find a fixed-rate loan with a lower interest rate than the multiple debts you are paying off. Use the loan funds to pay off your high-interest debts, and voilaĆ³you now have a single, lower-interest payment to make your life easier and help you repay your debts faster.

Home equity loan: Much like a debt consolidation loan, a home equity loan can be used to consolidate debt at a better rate. However, this option is risky because you are staking your home on your ability to repay the loan. So, make sure that the terms are within your means to repay.

401(k) loan: If you have a substantial amount of retirement savings invested in your 401(k), you might be permitted to take out a loan against it that could have a lower rate than your current, multiple debts. Just like a home equity loan, however, this strategy carries risk, as defaulting on your 401(k) loan payments can have drastic consequences for your retirement. So, use this option only if it makes sense in your situation and with your ability to repay.

Should I, or Shouldn't I?

When it comes to debt consolidation, there are a few basic questions to ask yourself to determine whether this is something you should do.

Debt consolidation might be a smart move for you if your monthly income is more than enough for you to consistently make on-time payments, and you have confidence that it will continue to stay that way for the remaining period required to pay off the debt consolidation within the required term.

If your debt payments are already beyond 50% of your monthly gross income or you have a problem with excessive spending, then debt consolidation is probably not going to be helpful; instead, you should look into more specific forms of debt relief. There are custom-tailored debt relief programs for situations like this.

Likewise, if you can already pay off your debts in a short period of time at the current rate (say less than a year), then the effort to consolidate is probably not worth the amount you will save. Everyone's situation is different, so you will need to consider your options and see which path is the right one for you.

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