Consolidating your debt is a sound financial strategy that allows you to combine multiple debts and make one monthly payment. This solution is great for simplifying your payment schedule and lowering debt. Consolidating your debt might seem like a quick fix of paying off your debt but there are some strings attached that might cost you more than you think.
Debt consolidation comes at a price. It has a few drawbacks that depend on the state of your current finances. If you have debts with high interest and are struggling to pay them on time, you can find some relief by consolidating them.
This solution is better than a balance transfer if you have a good credit score. You will be able to reduce the number of payments you make each month, cutting out the stress of keeping track of which payment is due next. Still, this solution isn’t the best. We explore some of the biggest downsides of debt consolidation.
Added Costs
The added costs of a debt consolidation fee are too many. These include the loan origination, balance transfer, closing, and annual fees. When you choose a repayment period of 7 to 10 years, another charge gets added on top of these four for extending the period.
So, ask the lender about all fees and any penalties on early payment. Read the fine lines of the contract carefully and negotiate with the lender on the interest rate.
A Small Drop In Your Credit Score
Consolidating your debts will increase your credit score, no doubt. It will lower the numbers temporarily. When you combine all your debts, you open another credit account. The hard inquiry into your credit history to determine whether you are eligible for a new account will affect your credit score.
Your credit score is calculated based on the age of your account. Since you will be moving your debts to another account, the drop in the payments on the previous account will lower the overall credit score.
Possibility Of High-Interest Rate
Yes, consolidating your debt offers you a lower interest rate. The interest rate will be high if you have a low credit score. You can shop to find one that allows you to make budgeted monthly payments, but chances are, it will still be more than what you were paying before.
Since the monthly payments will be higher, the period to pay back the loan will be longer, increasing the overall cost. After consolidating debts, you will no longer need to set reminders on your phone about the next payments you need to make. You might feel debt-free but don’t let yourself go loose at this stage.
Avoid accumulating more debts by making costly purchases because they will only increase the interest rate. If you are struggling with your debts, consolidating them makes sense.
We recommend trying other methods, such as prioritizing the payments. Pay off the debts with high interest first to bring your DTI below 30%. If you don’t have a stable income and your credit score is lower than 670, you need to look into alternative ways to pay off the debts because consolidating them will cause more financial distress.
