What Is Debt Consolidation?
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Debt consolidation is a special type of loan that allows you to combine all your debt into a single streamlined loan. This can include your car payments, credit card debt, and personal loans. Debt consolidation may seem strange to many people as they wonder: how can a new loan help address all my previous loans?
The fact is that the debt consolidation process is structured in a way that allows you to pay a lower interest rate, which, in turn, reduces your monthly payments and allows you to pay off debt. Despite the lower monthly payments, it allows you to pay off your loans quicker than the time it takes with traditional loans. Last but not least, debt consolidation offers convenience, simplifying debt management to a considerable extent.
How Does the Debt Consolidation Process Work?
The debt consolidation process varies, based on your preferences. Here’s a breakdown of how it works.
How Can I Consolidate Debt Without a Loan?
- Register for a credit counseling session.
- Discuss your debt situation with a credit counselor. They will evaluate your budget (income and other expenses) as well as your debt.
- If you have sufficient income that can pay for both your current expenses as well as make regular monthly payments, then they may recommend you to get a debt management program.
- Some credit counseling companies are affiliated with credit card providers. Due to this reason, you may have to pay a lower interest rate and fewer fees via the debt management program.
- The debt consolidation process ends with your approval. The objective of these programs is to automate your monthly payments, wiping out the entire debt in three to five years.
How Can I Consolidate Debt Without a Loan?
- Create a table and list down all the loans on a paper or a spreadsheet. Specify the total amount owed, the interest paid, and the monthly payment due.
- Mention how much you need to pay for each debt in a separate column.
- Approach a credit union, a bank, or an online lending source and apply for a debt consolidation loan for your complete debt. Look into its monthly payment and interest rate.
- Compare your debt consolidation loan with your original loans.
- If your calculations show significant savings with the debt consolidation loan, then you can apply for it immediately.
A counselor can also help you to evaluate your spending habits and recommend you to cut down costs accordingly. For instance, they might ask you to avoid overspending on costly electronics. They are also likely to discourage you from using credit cards, with the exception of a single card that can pay for your emergency expenses.
What Debt Can You Consolidate By Undergoing a Debt Consolidation Process?
There are no interest rates on utility bills and medical debt. Although it is possible to consolidate them with a loan, there’s no benefit of putting them in a loan that accrues interest. However, if you choose a suitable debt management program, then it can help with paying your bills without the accumulation of interest.
The Impact of Debt Consolidation on Your Credit
You can improve your credit rating by going through the debt consolidation process. Since the lenders only perform a soft-pull on your credit, there’s no impact on your credit score. However, a small credit drop is expected because the credit reports show you have more debt. Don’t worry, this is only temporary.
After you make regular payments and reduce your debt with a debt consolidation loan, it takes only a few months for your credit score to grow back. Over time, you will be successful in building a stronger credit history and boost your score permanently.
When to Opt for a Debt Consolidation Process
It is a good idea to choose a debt consolidation loan if the following scenarios reflect your current condition.
- Your credit card balances continue to increase.
- Your spending is higher than your income.
- You are only paying a minimum amount for your debt.
- You own credit cards that have an interest rate of 19% or more.
- Your debt-to-income ratio is a lot worse than the national average.
When Not to Opt for a Debt Consolidation Process
A debt consolidation loan will not work for you in the following situations.
- Debt collectors are continuously chasing you.
- Your credit cards have maxed out.
- It’s no longer possible to pay for your utility bills.
What Are Your Alternatives?
If consolidating debt doesn’t work for you and you don’t want to file a coronavirus bankruptcy, you may want to consider the following options:
Debt stacking, also known as the debt avalanche method, arranges your debt in terms of interest—from the highest to the lowest. Pay the minimum allowed limit for each of your credit card. The remaining amount is used to pay off the credit card debt with the highest interest rate. In this way, you can complete your loans one-by-one and save more money.
The snowball method works similarly to debt stacking. In the snowball method, you will sort out all the debt in terms of balance, from the lowest to the highest. Next, you will pay the minimum allowed balance for your credit cards. Moving ahead, pay off the card with the lowest balance first. Continue this strategy to move from one card to another. This debt is psychologically beneficial as paying off your debt can give you a sense of relief and motivate you to wipe out all the debt.
The debt consolidation process may not appear like the easiest solution, but it is a lot more promising than you might think. If you fit the bill, then it is an effective tool that can put you back on track and allow you to improve your financial condition gradually.