The prospect of living under debt for a long time is stressful, which is why some people resist the idea of getting a credit card or taking out a loan. However, for most people, getting a loan is necessary for living. Loans are often used to finance anything from higher education, home mortgages, and even life emergencies. The trick is to take out loans only when you really need it and make sure that you’re always on top of your monthly payments.
In life, however, you should also expect that things don’t always go according to plan. Whether through negligence or force majeure, debt can overwhelm a person’s life. As a result, many people end up paying multiple loans at different rates, and this can make monthly payments harder to keep up with. This is where debt consolidation comes along.
What is debt consolidation?
Debt consolidation involves using one loan to pay off all existing debt. This is fairly common in people who acquire debt in two or more credit cards, but it also happens in other types of loans.
To consolidate your debt means that instead of paying two or more banks all asking for different interest rates, you will be paying one. Often, this also results in lower monthly payments and interest rates because you’re only paying a single creditor. In this best-case scenario, the repayment process is simplified, and more of your monthly payments go to paying the principal loan. However, debt consolidation is only possible when you have a high enough credit score. Sometimes, a creditor might not even approve your personal loan at all.
When debt consolidation is a good idea
Consolidating your debt is a good idea if:
- You pay on time
Your credit score is influenced by several factors, but keeping up with your monthly payments has the greatest impact. This also ensures that you are not paying any late payment fees needlessly.
- You have reduced charges on your credit cards
The rule of thumb is to never use more than 30% of your credit at any given time. This is to keep a healthy credit utilization, or the ratio of credit used to credit available. This also has a significant impact on your credit score.
- You have changed spending habits
Debt consolidation doesn’t make your debts go away, but it merely simplifies your monthly payments by making you liable to one creditor. Because of this, it doesn’t make sense to acquire more debt. Use this leeway to pay your debt faster instead. If you don’t change your habits and continue to incur charges on your other credit cards, you will have just gained whatever savings you acquired in the consolidation.
Meanwhile, debt consolidation will not improve your situation if:
- You can’t pay on time
Aside from incurring penalties and charges due to late payments, it also hurts your credit score.
- You have a history of rejected loan applications
Banks are always trying to reduce risk on their investments. Applying for loans that you are not qualified for many times in a row tells the bank that you are not in a good financial situation. This hurts your credit score as well.
While often helpful for people who struggle to keep up with their monthly payments, debt consolidation does not erase your debt. If you’re having trouble paying off your loans, then the best solution is still to either decrease your spending or increase your income.
Good Neighbors Credit Union offers local credit union banking services and good savings account interest rates in Buffalo and Depew, NY. No matter where you are in life, no matter what financial situation you are facing, we believe that you deserve the best tools and resources to manage your finances.
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