Managing multiple debts with different due dates and interest rates can lead to missed payments and higher charges, which can quickly get out of hand and hurt your credit score. This financial stress doesn’t just affect your money but also your overall well-being, causing constant anxiety and worry.
Debt consolidation can help by combining all your debts into one loan with a single monthly payment. However, you need to consider the terms of the new loan, any fees, and if it really benefits your financial situation. It’s important to think about these factors to decide if debt consolidation is right for you.
So, is debt consolidation a good idea? Keep reading to learn more about this process and what it involves.
- What is debt consolidation?
- Pros of debt consolidation loans
- Cons of debt consolidation loans
- When to consider debt consolidation
- How to consolidate your debt
- Sun Loan can help with debt consolidation
What is debt consolidation?
Debt consolidation, also called credit consolidation, is a way to manage debt. When you consolidate debt, you combine all your separate debts into one debt with better terms. This means taking out a new loan, also called a consolidation loan, to pay off existing debts, like credit card balances, personal loans, medical bills, or other types of debt. Consolidating debt makes repayment simpler and can reduce the overall interest rate you pay.
Once you qualify for a consolidation loan, you use it to pay off your existing debts. This leaves you with just one monthly payment to manage. This makes it easier to keep track of your finances because there’s only one due date and one creditor to deal with.
You can consolidate debt in different ways, like getting a personal loan or refinancing a mortgage. Each way has its own benefits and requirements. However, you should always consider the terms and fees of a new loan or credit product and how it might affect your credit score.
Is a debt consolidation loan a good idea? While debt consolidation can help and make repayment easier, you should make sure it fits your financial goals and situation. For example, are you trying to get rid of debt to prepare for tough times, or are you looking to simplify monthly payments to improve your credit score for a long-term goal, like buying a home?
Pros of debt consolidation loans
So, how do you know whether debt consolidation is right for you? Here are a few benefits to consider:
Combine multiple debt payments into one
When it comes to organization and remembering to pay off your loan each month, debt consolidation can help since you combine all of your previous debts into one easy loan payment. This makes life a little bit easier and more convenient.
Save money with a lower APR
One of the biggest reasons to consider consolidating debt is getting a loan that offers a lower APR or interest rate than your current loans and debts when comparing them on the same or shorter payoff timeline. With a lower APR, you can save money since the added interest and fees may be less than any of your existing loans with a higher APR. Be sure to shop around and research the best rates for debt consolidation loans since consolidating your debt makes the most sense when you can do so at a lower APR with a shorter payoff period.
Pay off debt faster
By consolidating your debt into one loan, you might be able to pay off your loan faster. A debt consolidation loan can offer more room to put extra money toward the principal.
If the loan you receive to consolidate your debts doesn’t have a prepayment penalty (a fee that some lenders charge you if you pay off a loan early), it may make sense to take the same amount of money you would have paid for all your previous debts and put it all toward the new debt consolidation loan. Doing so can help you pay off the loan even quicker, which could save you money on interest.
Increase your credit score with on-time payments
Payment history is the most important factor in determining your credit score. When you make on-time monthly payments, you show lenders that you are a trustworthy borrower, resulting in a higher credit score. If you don’t make your payments on time each month, it’s the opposite effect–your credit score drops, which tells lenders that a loan might be risky. When you consolidate your debt, you only have one monthly loan payment, making it easier to pay on time and increase your credit score.
Cons of debt consolidation loans
As with many loan options, there may be some reasons that debt consolidation isn’t the best option for you. Here are a few reasons why consolidating debt might not be right for you:
Doesn’t address poor financial habits
Debt consolidation can make monthly payments easier, but it doesn’t fix the bad financial habits that may have caused your debt. If you consolidate your debts without changing these habits, you might end up in a worse situation. For example, you could take on a larger loan or keep using credit cards without paying them off, leading to more debt on top of your consolidated loan.
As we mentioned earlier, consolidating your debt really only makes sense if you can improve your financial situation. A big part of that is taking out a loan with a lower APR or interest rate than your current loans when looking at them over the same time period. Doing so may help you save money.
Excessive additional charges
Whenever you take out a loan, there will be fees and charges. These can add up and cost you extra money you may not want to spend. Ask each potential lender about their fees, and then do the math to determine whether a debt consolidation loan is worth those charges–especially a prepayment penalty, which is what some lenders charge you for paying off a loan early (not Sun Loan, however, we never charge prepayment penalties!).
APR may increase
Some lenders may offer you a special or promotional APR for a certain amount of time to get you to do business with them. For example, a balance transfer credit card may offer you a 0% APR for a year–meaning you only pay off your principal each month for a year without any extra fees or interest added on. However, once that year is up, your monthly payments will likely increase once the APR kicks in.
Another example is a variable rate loan, whose interest rates can change each month…for better or worse. If you prefer to have the same payment, look for a fixed rate loan with the lowest possible APR.
Longer payment term leads to more payments
Longer payment terms can be beneficial because they stretch out your payments so your monthly bill is more affordable. However, doing this extends the time you’re actually paying off your debt, which isn’t always ideal for people looking to become debt-free. Also, remember that the more months you need to pay off your loan, the more interest you’ll pay over the life of the loan. Doing so may end up costing you more than your previous debts.
Negative impact on credit score
Do consolidation loans hurt your credit score? Yes, consolidating your debt can impact your credit score. How does debt consolidation affect your credit? This depends on several factors.
First, as we mentioned, the lender will run a credit check when you apply for a debt consolidation loan, resulting in a hard inquiry that can drop your credit score by double digits. That generally only lasts for two years, however.
Your credit score could also suffer if you close your credit cards or accounts that were paid off by consolidating your debt. That’s because the average age of your credit accounts makes up 15% of your credit score.
When you open a new account or close an older one, the average age of your credit history decreases, which can also lower your credit score. We recommend keeping your old credit cards and accounts open, even if you don’t plan on using them. Just be sure to be mindful of your spending habits with credit cards if you choose to keep them open.
When to consider debt consolidation
Is a consolidation loan a good idea? You should think carefully about your situation before deciding. The goal is to make sure it’s the right choice for you. Here are some situations when you might consider debt consolidation:
- You want to simplify your debt payments: Consolidating your debt can make your finances easier to manage and reduce the risk of missed payments if handling multiple monthly payments and due dates is difficult.
- You have a good credit score: A fair or better credit score can help you get a lower interest rate on a loan.
- You can afford the payments: Before consolidating debt, check your budget to make sure you can comfortably afford the new payment.
- You have a plan for improving your financial health: Debt consolidation works best with better financial habits. Think about why you got into debt and create a plan to avoid similar problems in the future.
- You can pay off the loan within five years: Consolidating debt is most helpful if you can pay off the loan within a reasonable time, like five years. Taking longer could mean paying more in interest.
How to consolidation your debt
A debt consolidation loan isn’t the only way to combine your debts into one reasonable amount to pay off. In fact, there are quite a few options to consider when you want to consolidate your debt.
Personal loan
One option to consolidate or pay off your debt is to take out a personal loan. There are many types of personal loans, but they’re not the same as a debt consolidation loan. What’s the difference between a personal loan and a debt consolidation loan? You may use a personal loan for many expenses, including debt consolidation.
If you take out a personal loan, you could use a portion of it to consolidate your debt by paying off all your credit cards and other debts and then use the rest for another expense.
Debt consolidation loan
A debt consolidation loan, on the other hand, is a personal loan that is usually used only to consolidate two or more debts. Lenders may not allow you to use this type of loan for anything else, like you would for a personal loan. As we’ve covered, with a debt consolidation loan, the lender pays off your existing debts, and then you pay off the new loan.
Balance transfer credit cards
We briefly discussed balance transfer credit cards as an option for consolidating your debt. A balance transfer credit card allows you to move unpaid debts, such as credit card balances and various types of loans, from one or more accounts to a new or different credit card. It’s a popular choice because many credit card lenders offer a low or 0% introductory APR that allows you to pay off your debt with little to no interest for a period.
Just make sure you can afford the payments once the introductory rate ends. Like a debt consolidation loan, a balance transfer credit card streamlines your debts into one monthly payment.
Debt management plan (DMP)
Another possibility is a debt management plan (DMP). A DMP combines multiple debts into one monthly payment, and creditors reduce your interest rate. In return, you agree to a payment plan between three and five years.
While there are benefits to a DMP, especially with interest rates, there are a few things to keep in mind. First, you can generally only use a DMP to pay off credit card debts. Most agencies will not allow you to use a DMP for other debts, like student loans, taxes, or medical expenses. And while you are using a DMP agency, you may be charged a monthly fee. Also, during those three to five years, you likely won’t be able to use credit cards or open another form of credit.
Finally, missing a payment is never a good idea. One missed payment may cause the agency to end your low interest rates.
Sun Loan can help with debt consolidation
Consolidating debt can help simplify your finances and save money on interest. However, it’s important to check if credit consolidation fits your financial goals and situation. Look at the new loan’s terms, any fees, and how it affects your credit score. The decision should help you achieve long-term financial stability.
Sun Loan is ready to help with your debt consolidation! Through a personal installment loan, you can simplify your monthly bills and take back control of your finances. We offer loans up to $10,000 to help you pay off your debts through an affordable monthly payment that–when paid on time–can help you build your credit score.
With a single personal installment loan from Sun Loan, you only have one payment to deal with each month. Plus, you can lock in a fixed interest rate, so your monthly payment is never a surprise. Apply online today or visit us at one of our many convenient branches. If you’d like to speak to a loan expert, call us at (800) SUN-LOAN.
