No matter how careful you are with your finances, debt happens. There are big debts that are worth taking on such as student loan debt to get a college degree or a mortgage to buy your own home. There are other types of debt that should be avoided if possible, such as credit card debt. The trick is to not let the debt become overwhelming so you don’t become part of the 26% of Americans who are struggling to pay their monthly bills. That’s why many people try debt consolidation.
Debt consolidation is a simple strategy in which you take the various amounts that you owe on credit cards, car payments, and other outstanding debt and combine them into a single payment. With debt consolidation, you aren’t dismissing the debt, but you are restructuring it to make it easier to manage. Typically, you use a personal loan or low-interest credit card to pay off your debt, essentially transferring what you owe to the loan or card with regular payments at a lower interest rate.
However, debt consolidation is not a panacea, and you need to be cautious about how you use it. If you are not careful, you could end up exchanging one set of financial problems for another, or even putting yourself in a worse financial situation.
When to Consider Debt Consolidation
There are different types of debt. If you have a mortgage or student loan debt, then you are in good company. One in five American adults, or 44.7 million people, are carrying student loan debt, with average monthly payments ranging from $200-$300 per month. Most people manage to work mortgage and student loan payments into their budget.
Credit card debt is probably the biggest problem for most people. The Federal Reserve reports that Americans owe $1.04 trillion in credit card debt, up from $854 billion five years ago. Only 40% of Americans can pay their credit card balance each month, and the remaining 60% find themselves paying more and more in interest charges.
If you find your bills are creeping beyond your ability to pay them each month, then you might want to consider debt consolidation, but only if you meet these four criteria:
- Your total debt (including mortgage) is less than 40% of your gross income.
- You have good credit and can qualify for a low-interest credit card or loan.
- You have enough money to make the minimum monthly payments for the new loan.
- You have a plan to get out and stay out of debt.
Pros of Debt Consolidation
If you think that debt consolidation works for your situation, it does offer a number of advantages. For example:
- You put everything you owe into one payment, which makes it easier to manage as part of your household budget.
- You can repay the debt sooner because most repayment strategies will be shorter.
- You will avoid damaging your credit because you won’t be making late payments on various accounts or carrying a balance on multiple accounts.
- You will save money over the duration of the debt.
The best strategy for consolidating debt is to find a vehicle that will make it easier to repay the debt at a lower interest rate. If you can find a credit card or personal loan at a lower rate, you will pay less in interest over the life of the loan. Keep an eye out for special promotions happening at your local credit union.
Cons of Debt Consolidation
When considering debt consolidation, it’s important to be honest with yourself about your ability to repay. If you can’t manage the new, consolidated debt payment or you run up more debt, then a debt consolidation strategy won’t help you. In fact, it will likely make things worse.
Here are some of the negative factors to look at when considering debt consolidation:
- It won’t fix your debt problem. Remember, you are merely moving your debt from one place to another, so be sure you can pay down your debt and aren’t just rearranging the deck chairs on the Titanic.
- It won’t prevent you from running up additional debt. Once you pay off your credit cards, you may be tempted to start using them again. That’s how you ran up your debt in the first place. Once those debts are paid, put those cards away, or use them only for a real emergency.
- It might cost you money. Borrowing money often incurs fees. For example, some personal loans have origination fees from 1-8%, and home equity loans come with many of the same fees as mortgage applications.
Before you decide to consolidate your debt, consider carefully whether the new loan payments will be easier to manage within your budget, and whether you have the discipline to avoid taking on additional debt.
If you are considering debt consolidation, the financial experts at iQ Credit Union can help. We offer a number of financial tools that can help with debt consolidation, including personal loans, a home equity line of credit, and credit cards with competitive rates.
Contact us today and get expert advice on how to manage your debt.