The pros and cons of debt consolidation

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Debt consolidation is a way to combine multiple debt sources, such as high-interest credit cards or medical bills.

If your annual percentage rate is lower, a consolidation loan or a credit card with a balance transfer may make sense. However, debt refinancing comes with its pros and cons.

The Advantages of Debt Consolidation

You might receive a lower rate.

The greatest benefit of debt consolidating is the ability to pay down your debt at lower interest rates, which could help you save money and eliminate debt quicker.

If you have $ 9000 in total debt and pay $ 500 per month, $ 2500 interest will be charged over the next two years.

If you took out a consolidation loan for debt with an APR of 17% and a 2-year repayment term, your new monthly payment would be $445, and you’d save $ 820 on interest. You could use the money you save by paying a lower monthly payment to repay the loan sooner.

You will not have to pay interest if you are eligible for a balance transfer credit card. This promotion can last up to 18 months. A balance transfer fee of 3 to 5% will be required.

To see your total debt, monthly payment, and the combined interest rates of all your debts, use a debt consolidation calculator.

Only one monthly payment

Consolidating debt allows you to consolidate your payments into one single payment. The fixed interest rate won’t change over the life of the loan or during the promotional period when a transfer card balance is involved.

It’s more than just simplifying your payments. Consolidation can provide a clear and motivating way to get debt relief, especially if there is no debt repayment plan.

Your credit could be built.

A serious credit investigation is required before you apply for any new credit. This can temporarily lower your credit score.

But, if you make your monthly payment on time and in full, the net effect should be positive, mainly if your credit card debt is consolidated.

Your credit utilization rate is one of the most important factors in determining your score. You can pay off credit cards balances.

The Disadvantages of Debt Consolidation

A low rate cannot be used.

It can be challenging to get balance transfer cards. They require excellent credit (690 and higher on the FICO score).

Consolidated debt loans are easier to access and are suitable for applicants with bad credit (629 or lower on the FICO score). The rates are usually lower for those with higher credit scores.

Debt consolidation is not recommended unless the lender offers a lower interest rate than your current debt. Consider alternative strategies such as debt avalanche and debt snowball to repay your debts.

Pre-qualification with lenders is possible for borrowers who wish to consolidate loans. This will allow them to view potential rates and not affect their credit score.

It is possible to fall behind in payments.

You might end up in a worse place if you don’t repay the new debt.

If you fail to pay your balance transfer card within the promotional interest-free period, you will be required to pay it off at an increased APR. This could potentially make the debt even more expensive.

You could be charged late fees or missed payments if you default on your consolidation loan. This can put your credit score at risk.

Make sure that the monthly payment for consolidation fits within your budget for the duration of the repayment period.

The root problem was not solved.

Consolidation is an effective tool, but it does not solve the recurring debt. It also doesn’t address the behavior that caused the debt.

Consolidating your debts could be risky if you’re struggling with excessive spending. For example, if you take out a loan to pay off credit card debts, your cards will have a zero balance. They might even be tempting to be used before you have paid off the new debt, which could lead to deeper financial troubles.

You might consider a credit counselor at a respected nonprofit to help you create a plan for managing your debt.

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Jackie Veling writes for NerdWallet. Email: jveling@nerdwallet.com.

NerdWallet originally published the article Pros and Cons of Debt Consolidation.

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