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Debt Consolidation 101: What Is it, And How Does It Work?

what-is-debt-consolidation

Debt consolidation allows you to pay off multiple debts at once, so that you only have one monthly payment instead of several. This makes it easier for you to manage your finances and stay on top of your bills.

What is debt consolidation?

Debt consolidation is the process of taking out a loan to pay off other outstanding debts like credit cards and other high-interest debt — consolidating debt into one monthly payment at possibly a much lower interest rate.

Why Should I Do Debt Consolidation?

If you're struggling with too much debt, then you should consider consolidating your debts into one loan. By doing this, you will save money by paying less interest each month and you won't have to deal with any late fees.

Benefits Of Debt Consolidation?

There are several benefits to debt consolidation.

Reduce monthly payment.

When debt is consolidated into one payment, your overall monthly payment is likely to decrease because future payments are spread out over new loan terms.

Reduce interest rates.

Applicants with good credit scores have the most opportunity to lower interest rates with a debt consolidation loan. Rather than paying back multiple debts and interest rates, a debt consolidation loan with a fixed interest rate can make your monthly bills more affordable.

Pay off debt faster.

On average, Americans carry $6,194 in credit card debt, according to a Experian Consumer Credit Review. If making only the minimum payment, it’s not uncommon for credit card balances to take years to be paid in full, and that's if you don't make any more charges. If you continue to make charges your balance will increase. For this very reason, debt consolidation loans have a shorter payback period.

Boost credit score.

Debt consolidation may help improve your credit score by lowering the amount of credit you’re using (credit utilization) compared to the total available amount of credit. When you're close to maxing out your credit cards your credit utilization rate is high which can hurt your credit score. Ideally, your utilization rate should be under 30%, and consolidating debt can help you accomplish that.

Peace of Mind.

Combining multiple outstanding debts into a single loan reduces the number of payments and interest rates you have to worry about.

what-is-debt-consolidation

Graphic Courtesy of Bankiful.com

How Much Can I Save By Doing Debt Consolidation?

If you're looking into debt consolidation, you should first determine how much you can save by doing so. This will help you decide whether or not it's worth it to consolidate your debts.

How Long Will My Loan Be For?

Once you've determined how much money you can save by consolidating your loans, you'll need to find out how long you plan to keep your loan for. Most people choose between three and five years, but some people choose to extend their loan for as long as possible.

How Do I Know Which Company To Choose?

There are several different companies that offer debt consolidation services, so make sure you're comparing apples to apples when choosing one. Look at things like fees, interest rates, and repayment options. Also consider whether the company has any special offers or incentives for customers who sign up with them.

Do debt consolidation loans hurt your credit score?
The hope is that debt consolidation loans will help your credit score over time. Initially, you may see a slight dip in your credit score due to the hard credit inquiry when you apply for the loan. But making on-time payments and reducing credit utilization may have positive impacts and help boost your score in the long term.

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