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Debt consolidation is a way to restructure your debt into one loan, then pay it off with monthly payments to a single lender. This is an easy way to make sure you always pay the right amount and never miss a deadline. Sounds like a great idea, right? Not so fast! As with every debt relief solution, there are pros and cons to consider. Debt consolidation isn’t for everyone. In this post, we’ll examine what debt consolidation is, discuss its pros and cons, and explore some alternatives. By the end, you should have a better idea of whether debt consolidation is right for you!

What exactly is debt consolidation? 

Debt consolidation is a process where multiple outstanding debts are bundled together into one place and paid off through monthly payments to a single source. Depending on your situation, debt consolidation loans can typically carry lower interest rates than your multiple outstanding debts, like credit cards.

How does it work? 

Debt consolidation works by consolidating the balance from each outstanding account into one monthly payment, making it easier to manage. The trade-off is that the monthly payments on a debt consolidation loan are typically larger than making the minimum payment on outstanding debts, like credit cards.

When a person consolidates their debt, they are able to take on one big loan instead of having many smaller debts. This means that you make a payment to one place each month. However, these loans come with the downside of origination fees, which add to your outstanding debt.

What are the pros of debt consolidation?

When considering debt consolidation, there are several benefits that can make this an attractive option.

Make Things Simpler

Consolidating debts simplifies your monthly finances because you only have one due date to keep up with and the payment amount stays the same every month. Debt consolidation simplifies budgeting and reduces missed payments by combining the two or three monthly payments into one.

Reduced Interest Rates

For some candidates, debt consolidation provides an option to receive a lower interest rate than what you’re currently paying. Credit card rates average around 16 percent, while debt consolidation loans typically have a lending rate of 11.9%. However, your actual financing terms will depend on your credit score.

Know What to Expect

Debt consolidation can help you know what to expect when it comes to your monthly payments since you will be paying a fixed amount. By making this payment every month, you know that your payment and interest rate will be the same for the entire length of your loan.

Okay, so what are the cons? 

Challenging To Qualify For

One of the biggest hurdles with debt consolidation is that they can be challenging to qualify for. These lenders use your credit score to determine whether you qualify, how much you qualify for, and your financing terms. Even if you do qualify for a debt consolidation loan, it might not be enough to cover the full amount of your outstanding debts. This means you would need to make additional plans to deal with the uncovered portion of your debt.

There Are Quicker Options

With debt consolidation, it may take more time to get debt-free than with other debt-relief options. It typically takes 3-5 years to resolve debt with a consolidation loan. However, debt settlement can help you become debt-free in as little as 24 months. This is something to consider if you’re hoping to get out of debt quickly.

Debt consolidation can actually hurt your credit score if you fail to pay off the debt, which can be a concern given the longer term of payment. You can also face legal action if you stop paying on the loan.

You Could End Up Paying More

With debt consolidation, you pay off the full amount you owe and then some. Lenders charge what are called “origination fees”, typically 3-5% of the loan amount, increasing your total debt. So you will typically end up paying more than you originally owed. Financing terms for these loans will also vary based on your credit status. Meaning that if you have lower credit, your interest rate could be higher.  

Debt consolidation is a good option for some people, but not all. Before taking out a debt consolidation loan and before making any commitments, it’s important to explore all of your options. If you’re struggling to pay the full amount owed or cannot afford to, there are more advantageous debt relief solutions like debt settlement

Doesn’t Keep You From Going Into Debt Again

Consolidating debt can be helpful, but it doesn’t guarantee that you won’t ever go into debt again. If you have a history of living outside your means, consolidating may not help. To help avoid this, create and stick to a realistic budget and make sure you’re building a savings fund for emergencies so your credit card isn’t the only option when you need money.

When comparing debt-relief options, consider both your short-term needs and long-term financial goals to help make the best decision for yourself. 

What are alternatives to debt consolidation?

There are several alternatives to debt consolidation that might be a better fit for your situation.

Debt Settlement

The primary alternative we recommend is called debt settlement. Debt settlement is the process of resolving delinquent debt for a fraction of what you owe. Debt settlement offers might range from resolving up to 50% or more of the outstanding amount. This debt relief strategy helps you pay off your debt faster, for less money than you initially owe creditors. So it’s a good option if you cannot afford to pay the full amount you owe.

Aside from saving you money long-term, debt settlement companies provide options for affordable monthly payments, allowing you to keep more cash in your pocket each month.

Credit Counseling

A counselor reviews your financial situation to see if you qualify for a Debt Management Plan with monthly payments. If so, they negotiate lower interest rates with your creditors and create the new plan with monthly installments. Using credit counseling will help potentially lower your rates and fees, but it can paint you as a credit risk when you are looking for financing in the future. With credit counseling, you will still end up paying off the full amount owed and potentially more in interest if extending your repayment terms.

Bankruptcy

Chapter 7 and Chapter 13 are the primary bankruptcy options for individuals. If you file chapter 7, your assets will be evaluated and liquidated to pay off debt, with an estimated three to six month process time. While the immediate benefit is getting creditors off your back, there can be significant damage to credit in the long term which can affect future loans and purchases. Chapter 13 helps restructure debt, allowing debtors to repay their debts over a longer period of time, perhaps up to five years according to current guidelines.  

Bankruptcy also carries additional administrative and legal fees that can vary depending on your situation.

Cash-Out Refinance

If you own a home, you could consider covering your outstanding debts through a cash-out refinance. This type of loan allows you to roll your higher-interest debts into the mortgage of your house and spread repayment out over a longer period of time. While this might sound attractive, you will incur additional fees on top of your debt and you are putting your home at risk. Talk with an advisor before making this decision because it can have major implications for your finances for years to come.

Is debt consolidation a good idea for me? 

Debt consolidation might be a good idea if you have a steady income and an excellent credit score, and you hold significant debt. Debt consolidation might not be a good idea for you if you have bad credit, a lot of monthly expenses, can’t afford to pay what you owe or want to get out of debt as fast as possible. 

Where Can I Go For Help?

If you are struggling with debt and want to find a way to get out from under it, consider using a debt settlement company, like CreditAssociates. We’ve helped thousands of people just like you get back on top of their finances by negotiating with creditors to lower the amount owed, getting them out of debt faster and for less.

A Few More Common Debt Consolidation Questions: 

How does debt consolidation affect your credit score?

Overall, debt consolidation will not be likely to have a negative impact on your credit score unless you stop paying on it. A debt consolidation loan will be reported to the credit bureaus and should not have a dramatic effect on your credit score. When you pay off your creditors there are no late payments or derogatory remarks, thus providing very little negative information when reporting the payoff date with the credit bureaus.

What are the downsides to debt consolidation?

Debt consolidation loans can be hard to qualify for. Approval, loan amount and other financing terms are based on your creditworthiness. Debt consolidation can also end up taking longer when compared to other debt relief solutions, such as debt settlement.

How long does debt consolidation stay on my credit report?

The amount of time that debt consolidation will impact your credit score is dependent on what type of debt you’re consolidating, and whether or not the lender reports to credit bureaus. One thing’s for sure, though: consolidation will stay on your report until it is paid off in full, so if you aren’t able to pay back the consolidated loan, the consolidation could prove to be a problem.

Do you have to close credit cards after debt consolidation?

It’s possible that after debt consolidation is complete, you’ll want to close some of your credit card accounts to help prevent incurring future debt. However, if you have the discipline to keep up with payments and avoid the temptation of overspending, you might want to leave some open, as having open credit cards (with low balances) can help your credit score.

What happens if you don’t pay off your debt consolidation loan?

If you sign up for debt consolidation and can’t pay, you could face many problems. You could experience a negative impact on your credit score. Depending on your situation, you could also have your wages garnished, face legal action for unpaid bills, and risk losing property or assets if they were used as collateral on the loan.