Getting to know the pros and cons of consolidating multiple debts will help you determine if this is the right option to get out of debt. If you take a look at the current financial situation of Americans, you will realize that they are in dire need of a good debt solution.
A study reveals that 7 out of 10 Americans admit that they cannot pay off all their debts this year. Not only that, almost half of credit card holders who carry a balance say that it is very challenging to pay it all off. But if you have a definite debt solution, it might be easier to finally achieve debt freedom.
Of course, you should not choose just any debt solution. There are many ways to get out of debt but there is only one that will perfectly fit your financial situation. To help you choose, you should look at the advantages and disadvantages of the debt relief program.
If you want to know if consolidating multiple debts is the perfect option, here are the pros and cons of using it to pay off your debts.
Advantages of consolidating multiple debts
Starting with the pros, there are a couple of benefits to consolidating the different credit accounts that you have. If these are appealing to you, then it will make sense to consolidate debts.
Simple repayment plan
The first advantage of debt consolidation is the simple repayment plan. Sometimes, people can afford to pay all their debts. But since there are too many accounts to monitor, they end up getting confused. The result is missing some payments that lead to late penalty charges.
This is why consolidating can be beneficial. When you combine your debts, you will only monitor one payment each month. There is a lower chance that you will be too confused to forget a payment. With a simple repayment plan, you will find it easier to organize your budget plan.
Another advantage of consolidating multiple debts is feeling less stressed about your finances. Think about it this way. Let us assume that you are carrying 4 glasses filled with water. You may be able to carry it but if you hold on to it for a long time, it will get tiresome. But if you transfer the water from all 4 glasses into a bigger container, like a pitcher, it will be easier to carry the same amount of water.
If you have a lot of debts, all those accounts that you have to monitor can make you feel overwhelmed. As you struggle to organize everything, you will end up feeling a bit tensed and anxious about your debts.
Having a simple plan makes it easier to feel in control of your debt situation. You can easily organize your finances and keep track of the payments. If you are not stressed about your debt situation, you can focus on other things – like trying to earn more so you can pay off your debts faster.
Improve credit score
As you keep up with all your payments, it will reflect as a good entry in your credit report. Even if you started with a bad credit score, you will definitely end up with a better one. At least, this is true if you stay true to your chosen debt solution. Consolidating debts have positive effects on your credit score because it helps you keep up with payments. When you make timely payments, you also slowly bringing your credit utilization rate to a more acceptable level. If we use the FICO model, both the timely payments and better credit utilization rate will already be 65% of your credit score. So keep following the rules of debt consolidation and you should be able to enjoy debt freedom with a higher credit score.
There are two ways to save more when consolidating multiple debts.
The first is getting a lower interest rate on your debts. This is one of the qualifications of consolidating. If you cannot get a lower rate, then there is no sense in consolidating your debts. With a lower interest, you can save money in the long run.
The second thing that will help you save money is when you have a shorter repayment period. While it will force you to pay more each month, it will also help lower the interest amount that you will pay. If you already have a lower rate, you can expect to save more.
Pitfalls of consolidating multiple debts
Now that you know the advantages of consolidating multiple debts, it is time to discuss the risks that you can face. It is true that this is an effective way to get out of debt. But if it is not implemented properly or if it is not the right one for you, then it will lead to a lot of problems. Here are some of them.
Increase in interest payments
As mentioned, this is one of the main reasons to consolidate – to take advantage of a lower interest rate. But some people are just focused on combining their debts to make it easier to pay off. They end up choosing to consolidate even with a higher rate. While the single monthly payment is a welcome relief for some, you need to prioritize the interest too. When you consolidate, you have to pay a couple of fees. If you lower the interest, what you save can cover these fees.
Put collateral at risk
Another risk of consolidating multiple debts is putting your collateral on the line. At least, this is true if you use a secured loan to consolidate debts. According to reports, the housing industry is in a good condition that it is expected that there will be a rise in home equity borrowing. After all, the current home equity level is quite high right now – even higher than before the peak of the housing bubble back in 2006. If you have enough equity in your house, you can use this to get out of debt. But if you do that, make sure that you have a solid repayment plan. If you fail to pay off the loan, you might lose your house in the process.
False sense of debt freedom
Finally, a risk in debt consolidation is having a false sense of debt freedom. When you consolidate your debts, you will be paying off all your current ones. That will make you feel like you just achieved debt freedom. But the truth is, you used debt to pay it all off. You still need to pay that back. Technically, you just shifted your debts and put it under one loan. There is still a lot of debts to pay off.
Once you consider the pros and cons of consolidating multiple debts, it should be easier for you to decide if this is the right way to get out of debt. Unless you are sure, it will be best to look at your other options.