Debating The Pros And Cons Of A Debt Consolidation Loan
A debt consolidation loan allows you to pool all your debts into one and pay it off in single monthly payments. This helps you save money and time and makes you debt-free quickly. The question is: Is it right for you?
When Debt Consolidation Makes Sense
- If you have a Good credit score (Above 650).
- If the interest on your debts is high.
- If you have a foolproof repayment plan.
When Debt Consolidation Doesn't Make Sense
- If you don't plan on changing your spending habits.
- If you have a small debt.
- You have a Poor credit score (Below 580).
Improves Your Credit Score
When you apply for a new loan, your credit score drops by a few points because of the hard inquiry. However, a debt consolidation loan allows you to lower your credit utilization rate.
This loan will enable you to maintain a DTI of less than 30%. Through on-time, consistent payments, you improve your credit score.
If you have a good credit score, you will likely get a low rate on your new loan. Since all your debts will be combined into one for single payments, the overall interest rate will lower.
Reduced Monthly Payment
By consolidating your debts, you will be making single payments that will be lower than what you were paying before to different lenders.
Added Upfront Costs
A debt consolidation loan comes with added costs, including loan origination fees, annual fees, closing costs, and balance transfer fees.
You Might Not Get A Lower Rate
If you have a Poor credit score, you will get a higher rate than what you were paying on individual loans.
Paying More Interest Over Time
Since you will consolidate your debt, the monthly payments and repayment period will be revised. The latter will extend, which means you will pay more in the long run.
Alternatives To A Debt Consolidation Loan
Balance Transfer Card
A balance transfer card comes with a 0% interest rate, which allows you to make payments on your own time. However, this interest-free period lasts only one year. Only people with an Excellent credit score are eligible for this credit card.
You can try your luck by negotiating with the lender to settle your debt. You can also hire a debt settlement firm to talk on your behalf.
Home Equity Line Of Credit
Known as HELOC, this is a secured loan that you get against the equity in your house. In the first few years, you draw on the line of credit and pay only interest. Once you have used up the equity and the credit line is closed, you pay back the remaining interest and principal amount.
This loan, also known as mortgage refinancing, offers you a larger loan than the one you already have. You can use the difference to pay off your debt.
That's everything you need to know about a debt consolidation loan! Before approaching a lender, we recommend getting to the root of your spending habits to find out how you can cut back on expenses and pay off the debt without taking out a loan.