Debt Consolidation: Pros & Cons
Debt consolidation is a debt strategy to manage financial strain. But, is it good or bad? It could be a loan from banks, balance transfer from credit cards, home equity loans and so forth.
Lower your interest rates
Get the average interest rate of all your debts, and look for a consolidation plan that would help you get the most savings. If you compare loan rates, you can probably get 50% off your interests. Those who still qualify for balance transfer cards with 0% interests may do so, provided that they repay the balance within the intro period.
Let’s say you have $500 balance at 15% APR with Credit Card A, $400 balance with Credit card B at 20% APR and $600 debt at with Credit card C. By transferring your balance to Credit Card D which has 0% APR, you only have to pay the total balance which is $1500 without having to pay the interest rate.
Because you only have one payment to make it is easier to track and you have less due dates and creditors to think about.
Preserve your credit score
If you are in a tight spot and you opt for alternatives to consolidation like bankruptcy, it would damage your score. Bankruptcy would close your accounts and damage your credit.
So if you do it correctly and pay on time, you will be able to repay the loan within the term or even earlier.It also helps you avoid senseless spending because a debt consolidation loan is not something that revolves. You can avoid getting into debt again if you resist the temptation of using up all your other paid down accounts.
Knowing that you have to pay it on a specific period is also a pro. You don’t; have to worry about when it would end because the terms of the loan are clearly laid down before you before you sign away your future paycheck.
What will happen if you don’t close other accounts and start using them again after they were paid to zero and the payments come up? You won’t have the flexibility anymore. If you have the credit card bills on top of it, you’ll be struggling to pay it off.
Balance transfer has intro rate and the interest rate doesn’t stay that low at the lifetime of the balance. So, for the first month it could be 0%, and then you miss payment, and then the rate increases. If you have a system income, or one that is fixed, that’s not a problem. But if you have inconsistent income and spending, the balance transfer would be a stop gap, it would come back to you in higher interests more than you anticipated it to be.
You have to get approved for these types of debts. If you overstretched your financial reserves, your debts are too high and your debt to income ratio may no longer qualify you for debt consolidation loans or balance transfers.
Is there a right and wrong way to consolidate debts?
Debt consolidation loan is a great and powerful debt repayment tool that allows you to combine all the payments in one and save more money on interests. But there are many companies that take advantage of people in vulnerable conditions. So, before you make a decision to consolidate debt it is important to do the following things:
- Make a list of the pros and cons when you apply for a debt consolidation. Ask yourself if you will be in a better financial position should you take a loan to repay your debts. Then compare it with the consequences of getting a huge loan to replace some ones. Would you be overwhelmed and feel like you won’t be able to meet the repayments?
- Create a budget which is enough to cover all your household costs and emergency expenses. Make sure that you provide an allowance for unexpected expenses so that you wouldn’t have to use any credit until you have fully repaid the total amount of your consolidation loan. This is the most challenging step because it takes a lot of financial discipline.
One of the biggest cons of debt consolidation is that some borrowers can’t resist dipping into their credit cards. If you don’t cut down your cards or close it, you may be tempted to sue it again. When things become a little rough, you would turn to your card for cash. That is why it is practical to get a debt consolidation loan that allows you to get extra money to use as a capital for a business or a side job. By augmenting your income, you don’t have to work so hard on a tight budget.