When You Should (and Shouldn’t) Consolidate Your Debt
Debt consolidation may seem like a simple solution if you have multiple loans or credit cards and are struggling to keep up with all the separate payments. But consolidation isn’t right for every situation, especially if your goal is to quickly increase your credit score. So how do you know when it’s worth simplifying your repayment process by taking out a debt consolidation loan? Here are some tips on when it makes sense to consolidate debt and when it’s better to explore other options.
When Should You Consolidate Your Debt?
You have high interest debt
Consolidating credit cards or other debt charging more than 15% interest can help reduce overall interest costs. Transferring your balances to a consolidation loan with a lower rate can save you money.
You have too many accounts
Keeping track of multiple loan or credit card payments can be time-consuming and increase the risk of missing a payment. Consolidating everything into one payment through a debt consolidation loan simplifies the process.
Do you want a fixed interest rate?
Most consolidation loans offer fixed interest rates, which means your monthly payment remains the same over the long term. This makes budgeting easier than changing credit card rates.
Do you need a lower monthly payment?
If cash flow is limited each month, a debt consolidation loan can stretch out payments over a longer period, reducing the monthly amount owed.
You have a good credit history
You’ll get the best terms and rates for a consolidation loan if your credit score is 680+ and you have a stable debt-to-income ratio of less than 40%.
When not to consolidate debt
You don’t have a plan to reduce your debt.
Continuing to charge your credit cards after consolidating will not help your situation. Make a plan to change your spending habits and arrange to pay off your debts first.
Your balance is very high
If you owe more than $50,000 in unsecured debt, consolidation loans likely won’t cover the entire amount. Consider other restructuring options, such as a debt management plan .
You have a bad credit history
As noted above, consolidation loans with favorable rates usually require a good credit score. For scores below 620, this consolidation method may not be possible.
You can’t afford the monthly payment
Make sure the new consolidated payment fits reasonably into your budget. Otherwise, consolidation may do more harm than good.
You have low credit card rates
I generally recommend paying off high-interest debt first. If the rates on your current cards are below 8-10%, consolidation probably isn’t worth the cost. Focus on aggressively paying off those who have reduced these low rates before consolidating debts with higher rates.
You Can’t Afford Consolidation Costs
Here’s the interesting thing: Consolidation isn’t free. In most cases, you will have to pay a fee ranging from 3% to 5% of the transfer amount. Nerd Wallet has a great calculator to help you determine if it’s worth the cost in your situation.
Bottom line
In most cases, debt consolidation loans are not necessary. Think of it this way: debt consolidation loans are financial products, which means financial institutions wouldn’t offer them to you unless they made money from them.
However, debt consolidation makes sense if you can save money in the long run by securing a higher interest rate, or if streamlining will allow you to make payments on time. The key is to make sure this consolidation is part of a larger plan to get out of debt. Consolidating debts into a single loan may simplify the situation, but it is not a solution to underlying financial problems.