Debt consolidation is one of the popular options to get out of debt. And based on reports, a lot of consumers are in need of a good debt relief program to help them with their credit situation. The current credit card debt is now $1 trillion and it just keeps on growing. With an average of 20% interest rate, it is not If you add other debts, the amount is way too high for anyone to live in comfort and peace.
This is why people should start getting serious about debt relief. When left unresolved, it can really make things difficult – especially for your financial future. Credit card debts, in particular, will grow quickly because of the high interest rates. If you add mortgage loans, student loans and even car loan to that, it can all be too overwhelming to manage.
Fortunately, there is an effective way to get out of a tough credit situation – and that is debt consolidation.
The consolidation involves multiple debts that you will combine under one credit account. This brings a lot of benefits but the primary reason to consolidate is to simplify your monthly payments. Instead of tracking multiple credit accounts, you just have to monitor one.
5 facts about debt consolidation you need to understand
While it is no doubt effective, you still need to ensure that you completely understand what debt consolidation is all about. It can save you from the clutches of crippling debt but only if you know how to use and implement it properly.
To do that, you need to get to know 5 important facts about consolidating debts. These facts will help you decide if debt consolidation is the right path for you and which of the options you should use.
It only restructures your debts
First of all, you need to understand that debt consolidation combines your multiple credit accounts into one monthly payment. If you used balance transfer or debt consolidation loan, the original credit accounts will now have a 0 balance. Do not think that this is an indication that you have paid off your debts. You simply transferred all your balances. It is still there waiting for you to pay it off.
Some people make the mistake of thinking their debts are paid off. That is not true. Do not feel complacent because you still have a long way to go before you can say you are free from debt. You still have to start paying off what you really owe.
Not only that, you still have to address the real reason why you got into debt in the first place. Was it because of overspending? Or the lack of emergency funds forced you to borrow money after an accident? You need to solve these issues because if not, you might end up in another debt situation.
It might require a collateral
One of the goals of debt consolidation is to lower your interest rate. If you have a bad credit score, you cannot use a loan to consolidate debt. But if you have collateral, like a house with enough equity in it, you might be able to use this to get a lower interest on a Home Equity Loan or HELOC (Home Equity Line Of Credit). As it turns out, the use of HELOC for debts is not something new. Of those applying for HELOC, 18% say they intend to use it for debt consolidation but 24% end up using it for this purpose.
While this can be effective, you have to be careful too. If you fail to pay the loan back, you might end up losing your home.
It could make you pay fees
This is not for all debt consolidation options. It is mostly for debt management and balance transfer. When you opt for debt management, you need to pay the credit counselor a small fee (either a percentage of the debt or $50) each month. This fee will be paid for their assistance in creating a DMP or debt management plan. It is also to pay for their services as they present the DMP to your creditors and lenders. Finally, it is also their monthly payment because you will send all your monthly debt payments (based on the DMP) to them and they will be responsible for disbursing the amount to all your credit accounts.
As for balance transfer, the fee refers to the one-time payment that you will make when you transfer all that you owe into the new credit card with 0% interest rate. This is usually 3% of the total amount that you will transfer.
It can extend your repayment period
Another truth about debt consolidation is that it can lengthen your repayment period. This is only for those who want a lower monthly payment. If you are struggling to pay your debts because it is putting too much strain on your budget, then you need to stretch it over a longer repayment plan. This will allow you to lower the payment requirement each month. If you need to get out of debt faster, you have to increase your monthly payments.
It will depend on your credit score
You may have already guessed that there are several options to consolidate debt. If you think that you are free to choose just any of these, you are mistaken. You need to consider your credit score before you finalize what you will use. For instance, if you have a good credit score, you can use debt consolidation loan, HELOC or balance transfer. Without a good score, you will not get a low-interest rate on these options. You will end up paying more because of the high-interest rate. If you have a low credit score, you need to use debt management or debt settlement.
Other debt consolidation truths
Apart from the 5 truths that were just discussed, there are two more that you need to understand about debt consolidation. If you plan on consolidating debt on your own, you might want to get to know these facts.
You are allowed to consolidate various debt types
First of all, you are allowed to consolidate mortgage, credit cards, medical bills, and even auto loans together. Student loans may be consolidated but only if you have private ones. Federal student loans may not be allowed to be consolidated with other debts. You just have to check if there are prepayment penalties before you consolidate debts together. If there are, you might be better off using debt management. This option does not really combine your debts. But the single payment is still there. The credit counselor is the one in charge of disbursing the payments to the different creditors that you owe money to.
You should choose the debt consolidation wisely
There are many options to consolidate debt and you need to understand your payment capabilities to find the perfect solution. If you know that you need professional help, you can opt for debt management or debt settlement. If you need a debt reduction, debt settlement is another option to try. But if you do not have problems managing your own money, you might want to opt for debt consolidation loans or balance transfer.