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Is it a Good Idea to Get a Debt Consolidation Loan?

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Dan Steadman

Financial Advisor, DCL

Is it a Good Idea to Get a Debt Consolidation Loan?

Are you drowning in your debt? If so, you are not alone. Millions of people have been in the same position you are in, and there are options to consider that can help relieve you of your debt. The most important thing is to make an informed decision to determine the best path for you that will allow you to overcome your debt.

You may have heard both positive and negative descriptions of debt consolidation loans, and both may be true. Getting one can be a good idea, but it really depends on your financial situation. This is why it is so important to know and understand all the details and requirements of a debt consolidation loan or any other debt consolidation service.

What is a Debt Consolidation Loan?

The concept is simple. You take out a loan and use it to pay off your current debts. Easy, right? Well, it can be, but it’s not exactly that simple.  First, you need to make sure your loan has a lower interest rate than the credit cards or other debt you are looking to pay off. Second, it is essential that you can afford the monthly payments in order to pay back the debt consolidation loan.  The goal is to pay off or pay down your debt without causing any further damage to your credit score.

Interest Rates

Credit cards can charge interest rates up to and above 25%, which is one reason why it is so difficult for many consumers to not only pay down the balance, but just to make the minimum monthly payments after the interest rate has been applied. Take a look at the interest rate your credit cards are charging you, and then compare that to any debt consolidation loan options you may have or may be considering.  In most cases, you should be able to find a lender that will offer a lower interest rate than 25%.

A loan with a lower interest rate will actually save you money over time as opposed to continuing to pay each account with its own high interest rate. 

Monthly Payments

Many people with excessive debt find it difficult just to make the monthly payments because they are so high, particularly if they have more than one credit card that is near the maximum limit. Missing just one monthly payment can put you on the path to financial destruction.  You will be charged late fees, and the credit card lender may also increase your interest rate. If missing the payment puts you over your credit limit, you are in an even worse predicament, because you will be charged significant fees for going over the limit.

You should only apply for a debt consolidation loan if it offers a monthly payment you can afford. In most cases, the monthly payment will be less than the total payments you are making on your accounts now. Still, it is important to be aware of the payment amount and the length of the loan term.

Multiple Payments

Another issue many consumers find with overwhelming debt is the multiple payments they make each month to each individual creditor.  If you have 3 or more credit cards or debt accounts, then this may apply to you.  It can be confusing and difficult to keep track of how much you owe each company.

A debt consolidation loan can help in this aspect as well. All your payments will be rolled into one, so the confusion is eliminated, and you only have to worry about the one loan payment each month until the loan is paid off. This will not only help reduce your stress and anxiety when it comes to paying your bills each month, but if you remain current on your payments, you will eventually see an increase in your credit score as well.

As you can see, there are some significant benefits associated with a debt consolidation loan.  Keep in mind that there are some downfalls as well, and there are so many options and different organizations to choose from it can be overwhelming. Although there are many legitimate companies who offer debt consolidation services, there are also many predatory lenders out there looking to take advantage of people like you who are struggling with their debt.

What to Look for When Choosing a Consolidation Organization

A legitimate debt consolidation loan company or organization will allow you to take out a loan in order to pay your creditors.  Ideally, you will get a loan amount that will allow you to completely eliminate any balances on all your credit cards.  You will then repay the loan in monthly installments, including the loan fees and interest rates, until the loan is paid off.  If the loan is not enough to cover all of your debt, it may not work the way you want it to, because you will still be paying off another creditor with a high interest rate.

Before you sign the loan agreement, you should be aware of the details included in the document. If you have a bad or poor credit score, you can be charged a higher interest rate and higher loan fees, so it is important to understand all the fees and charges. You may feel desperate to get out from under your debt, but you want to make sure you are not getting into an even deeper financial struggle. Be sure to research the lender you are using to make sure they are legitimate.

Also consider the debt consolidation loan repayment term or loan period. Even if you are offered a low or reasonable interest rate, if the loan term is several years, you may end up paying more money back in interest because of the longer term. The lender should show you what the total payment amount is, so be sure to pay attention and consider this before you decide to pursue a debt consolidation loan.

There are a few other things to keep in mind if you do decide to sign for a debt consolidation loan. Missing a monthly loan payment can be detrimental to successfully reducing your debt. You will be charged additional late charges and fees, in addition to the lender increasing your interest rate. This will make it even more difficult to repay the loan, and it could pose an even bigger burden to your finances.

You should also consider that if your credit card accounts remain open, you should not use them. This defeats the purpose of a debt consolidation loan. The goal should be to eliminate all use of credit cards to avoid the high interest rates, and to avoid running up the balance until you are near the maximum limit. If you choose a debt consolidation loan, you should have a budget for your expenses and a repayment plan in mind. It is up to you be responsible with your debt in order to overcome your current situation.

What About a Balance Transfer?

Some credit card companies offer a low interest rate if you transfer all your other accounts into this one credit card. Many companies will offer 0% interest on all balance transfers – sounds great, right? While the “0” looks attractive, there are some loopholes you should consider before deciding to transfer your account balances to one single credit card account.

Sounds like a debt consolidation loan – you transfer all your accounts into one, and then make one monthly payment.  Meanwhile, the balance on your other cards goes down to zero. This will help your credit score increase, right? Well it can, but pay attention to the following details before you decide a balance transfer.

You have to read the fine print in the balance transfer details. First, you will be charged a transfer fee on the total of your transferred amount.  The fee is usually between 2 and 5%. So, if you transfer a total balance of $20,000, you will be charged anywhere between $400 and $1,000 for the transfer. This will be added to your credit card account balance, and increase your monthly payment amount.

The “0%” interest rate is usually an introductory offer that will expire after a few months, sometimes it may be up to a year. During this time, you will not accumulate any interest on the account balance, but you will have to make monthly payments on the balance. If you can make large payments to reduce the balance, then this may be a good option for you.  However, if you are only making the minimum monthly payments or barely above the minimum, this could come back to haunt you.

After the introductory period, the interest rate will increase.  This is where you need to read the fine print.  The interest rate could increase to above 20% once the introductory period has expired. So, if you’ve only been making the minimum payments, this is going to increase your balance and your monthly payment amounts. Depending on the amount you transferred, this could case even further damage to your finances, especially if you begin using the other credit cards that now have a $0 balance.

Other than balance transfers, there are debt consolidation alternatives you may want to consider prior to making your final decision. If you own your home, you may want to consider a home equity loan, which allows you to borrow money using your house as collateral. Peer-to-peer lending is available online. This is a relatively new concept that matches consumers who need a loan with other consumers who may offer a small loan to consumers with bad or poor credit.

So, Is a Debt Consolidation Loan a Good Idea?

After laying out all the terms, fees and charges, you may have a better understanding of what a debt consolidation loan is. Whether it is a good idea depends on the aspects of your finances and of the loan. A debt consolidation loan can be a good idea if it is used responsibly and if you are ready to reduce your expenses in order to live credit card-free. If you get a debt consolidation loan, you should be prepared to cut up all your credit cards and to only use the money in your bank account for expenses.

In order to determine if a debt consolidation loan is a good idea for you, you should make a list of all your accounts, the balances, interest rates, and the monthly payments. The account that has the highest interest rate should be paid off first, and so on and so forth. If you can make a budget that allows you to repay your debt without a loan, then you should pursue that option first, if only to reduce your debt to reduce the amount you need to loan.  The less money you loan and the shorter the loan term, the more money you will keep in your pocket.

Whether you decide to pursue a debt consolidation loan to pay down your debt, or you choose an alternative option, you should always understand the details before you sign any official agreement or document. Once you sign on the dotted line, there is no going back and you are bound by the terms included in the agreement.  This is why it is so important to understand the interest rates, loan term and the monthly payment amount.

A debt consolidation loan is definitely an option to consider if you are looking to reduce or eliminate your debt. If you can get a loan with a low interest rate, reasonable monthly payments and a relatively short loan term, then a debt consolidation loan is a good idea. Again, it really depends on you and your situation.  Regardless of the path you choose, keep these details in mind and pay attention to the fine print in any agreement or plan you are tempted to sign. This could save you a world of pain by preventing a situation where you are damaging your finances even further.

Dan Steadman

Dan Steadman

Financial Advisor, DCL

Dan is one of the top financial experts when it comes to debt consolidation. With more than 20 years of experience helping people tackle debt, he has a unique insight when it comes to solving debt-related problems. 

Dan got his start when he went to work for a bank after getting his Business Degree. He worked his way up and became a loan officer. This position gave him unique insights into the ways that financial products work and how people can utilize different financial products to improve their lives. He’s seen hundreds of success stories and just as many failures – so he knows what steps are most likely to help his readers.

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