Whether you’re struggling with credit card debt, student loans, or other debts that are simply too much to manage, debt consolidation is one of the many tools at your disposal that can help make a mountain of debt seem scalable. Debt consolidation isn’t for everyone, though. To help you decide if a debt consolidation loan is right for you, check out our guide:
What is a Debt Consolidation Loan?
A debt consolidation loan is a type of personal loan that essentially puts all of your debt in one place. Under a debt consolidation loan, you’ll only have to make one monthly payment. Debt consolidation consists of a borrower taking out a personal loan that covers all the debts they want to consolidate. Then, they pay off that loan over time.
Benefits of Debt Consolidation
Debt consolidation is an incredibly useful tactic for people struggling with multiple bills, each due at different times. With debt consolidation, you can: Organize and prioritize payments, like saving for retirement
All of your various debt payments will become a single payment. Depending on your loan terms, you may pay less each month than you were previously. Plus, all your payments will occur simultaneously– this is especially useful for people struggling with multiple bills due on different days. Pay off Loans Faster
If you have significant credit card debt, a debt consolidation loan will also allow you to streamline your payoff period, making it easier to pay off loans faster.Manage Payment Scheudle
One of the best reasons to take out a debt consolidation loan is that it essentially organizes all your debts into one pile. With a single monthly payment instead of multiple ones, it’s much easier for borrowers to stay on track with their payments, especially if they have multiple debts from several different lenders. Manage Interest Rates
When negotiating your loan terms with a creditor, many people end up with lower interest rates than the ones previously stated on their other debts. By consolidating your debts into one monthly payment, you are also consolidating all of their interest as well. You’ll pay less interest in the long run.
Drawbacks of Debt Consolidation
Unfortunately, debt consolidation has some drawbacks as well– it’s not for everyone. It Won’t Change Your Total Debt
The biggest drawback of debt consolidation is that it won’t change the total amount of debt you have. Instead, it lumps the debts together to make them more manageable. If you consolidate five $1,000 debts, you’ll still be $5,000 in debt. Additionally, your Interest may Increase. Especially in a rising interest rate environment.
Debt consolidation also relies on good credit to function well. You’ll need a good credit score if you’re looking to consolidate your debts with a lower interest rate. Otherwise, you’ll wind up with interest rates higher than your average.
When to Choose Debt Consolidation
Even though debt consolidation isn’t for everyone, there are a few things you can do to determine if it’s the right move for you. Generally speaking, debt consolidation may be a good idea if:
- You are responsible for your spending habits
- You have a low debt-to-income ratio
- You have a good credit score
- You can regularly pay more than the minimum monthly amount on your payments
Types of Debt You Can Consolidate
In addition to the drawbacks of debt consolidation, only three types of debt are available for consolidation. Credit card debt, student loans, and high-interest personal loans are the only debts eligible for consolidation.
Credit Unions vs. Banks
If you’ve decided that debt consolidation is the right solution, then it’s time to choose what lender you’ll consolidate with. You have two options: banks or credit unions.
The main difference between banks and credit unions is their status as for-profit organizations. Credit unions are non-profit organizations composed of several leaders. Credit unions do not have to pay taxes and are often held to strict government regulations. However, credit unions may not have as many physical locations or ATMs.
Banks, on the other hand, are for-profit institutions that focus on the needs of their account holders. They usually have a much smaller board of directors but are more widely available regarding physical location and ATM access. While banks may offer more lending options than credit unions, they also have higher fees, stricter lending requirements, and maintenance fees.
What is a Federal Credit Union?
Credit unions are also split into two types: state credit unions and federal credit unions. The only difference between the two is the rules they must follow: state credit unions must follow state-specific regulations. In contrast, federal credit unions follow regulations set by the National Credit Union Association.
Choosing Debt Consolidation With a Credit Union
When consolidating your debts with a credit union, it’s important to have a general idea of which debts you’d like to consolidate, as well as their interest rates and repayment schedules. A debt consolidation calculator provides potential borrowers with resources to build a rough sketch of what their consolidation loan may look like. Credit unions offer different calculators, so check with multiple calculators to compare your options.
Types of Loans
If you’re taking out a debt consolidation loan, then there are a few ways to do so:
Home Equity Loan
A home equity loan uses your home’s value as a baseline for your debt. While they offer lower interest rates and longer repayment terms, failure to make payments can result in the lender seizing your home and belongings. Home equity loans are best for people who can guarantee they’ll make payments regularly.
Balance Transfer Cards
Balance transfer cards are most often used for credit card debt and are sometimes offered by credit card companies to help customers consolidate their credit cards. Balance transfer cards only work for credit card debt. They offer a brief period of 0% interest which increases drastically once the period ends. They also have strict credit score requirements.
A 401K loan uses the money earned through your 401K to pay off your debts. These loans have no impact on your credit score and have low-interest rates compared to other available options. However, if you lose your job, you’ll have to pay back the loan within 60 days.
Personal loans are some of the most accessible loans out there because banks and credit unions offer them. You can use a personal loan for just about anything, but borrowers are subject to varying loan amounts and interest rates based on their credit scores and qualifications. For example, someone with a high credit score may be able to take out $10,000 with a 5% interest rate, while someone with a lower score may only qualify for $5,000 with a 10% interest rate.