What is the definition of debt consolidation? Debt consolidation is the process of transferring all your outstanding debts and loans into one loan. These types of loans should lower interest rates and help you pay off your debt faster.
Debt consolidation should be considered whenever you feel overwhelmed with monthly payments because it can get you out of debt faster with less money spent. Whether you’re struggling to make ends meet or just want to use your money more wisely, debt consolidation may be for you.
Know Your Credit Score – Whether true debt consolidation is a viable and smart strategy will depend on the terms you receive. Those terms will depend on your credit score. Therefore, you need to take inventory of where you stand in order to assess which realistic options will be available to you. If you have a great credit score, then a balance transfer may be a good option. If your score is on the low end, then the terms on a balance transfer or loan will not be as appealing and could create more harm than good.
Balance Transfer – A balance transfer involves opening a new credit card with a low or zero-percent interest rate (for a promotional period). You then move your previous debt(s) to this new credit card. In effect, you will have reduced your interest rate from a high rate on the old debt to a lower rate on the new card.
You will typically pay a fee for the amount you transfer (although some cards waive the fee for applicants with excellent credit), and there will be a limit to how much you can transfer (meaning you may not be able to transfer all of your existing debt).
A Debt Consolidation Loan – A consolidation loan works much like a balance transfer, but you would be receiving a loan rather than a line of credit. The process would involve opening the loan, using funds from the loan to pay off the previous debt(s), and then repaying the loan. Like with balance transfers, better terms will be reserved for borrowers with good to excellent credit.
To make this strategy worth it, a borrower should only accept a loan with an interest rate significantly lower than the rate on the existing debt(s). Some lenders may charge origination fees, but borrowers should shop around and try to avoid such fees.
As you can see, a lot goes into the decision to pursue debt consolidation. A balance transfer or consolidation loan may be the right solution for those who can secure good interest rates and avoid fees.
To learn more about where you stand and which path forward may make sense for you, speak with a credit counselor.