What is ‘Debt Consolidation’
Debt consolidation means taking out a new loan to pay off a number of obligations and debts of consumers, generally unsecured debts. In fact, multiple debts are merged into one larger piece of debt, usually with more favorable repayment terms: a lower interest rate, lower monthly payment or both. Consumers can use debt consolidation as an aid to settle student loan Humpty Dumpty loans, credit card debts and other types of debts.
Debt consolidation methods
There are different ways in which consumers can pay off debts in one go. One is to consolidate all their credit card payments into one new credit card – which may be a good idea if the card charges little or no interest during a certain period – or to use the balance transfer function of an existing credit card (especially if this one a special promotion for the transaction). Home equity loans or home equity lines of credit are another form of consolidation that some people pursue because the interest on this type of loan is deductible for borrower payers who specify their deductions. There are also several consolidation options available from the federal government for those with student loans.
Interrupt debt consolidation
Theoretically, the use of one form of financing to pay off other debts is the practice of debt consolidation. However, there are specific instruments called debt consolidation loans offered by creditors as part of a plan for borrowers who have difficulty managing the number or size of their outstanding debts. Creditors are willing to do this for various reasons – one of which is that it maximizes the chance of collecting a debtor. These loans are usually offered by financial institutions such as banks and credit unions; there are also specialized debt consolidation service companies.
There are two types of loans for debt consolidation: secured and unsecured. Secured loans are covered by an asset of the borrower, such as a house or a car, that acts as collateral for the loan. More traditional, unsecured debt consolidation loans, which are not supported by assets, may be more difficult to obtain. They also often have higher interest rates and lower qualifying amounts. However, the interest rates are still generally lower than the rates on credit cards. The interest is also fixed.
“Typically, the loan must be repaid within three to five years,” says Harrine Freeman, CEO and owner of HE Freeman Enterprises, a credit repair and credit guidance service in Bethesda, MD, and author of “How to Get Out of Debt.” “
These types of loans do not clear the debt; they simply transfer all your debts to another lender or loan type. (In circumstances where you need debt relief or are not eligible for loans, it might be best to look at a debt settlement instead of, or in combination with, a debt consolidation. The number of creditors. People usually work with a debt assistance organization or credit counseling service. These organizations do not make actual loans, but try to renegotiate the borrower’s existing debts with creditors.)
Advantages of debt consolidation loans
Freeman says that debt consolidation loans are most useful for those who have multiple debts, who owe $ 10,000 or more, who regularly receive phone calls or letters from debt collection agencies, have bills with high-interest rates or monthly payments, have trouble making payments or are unable to negotiate lower interest rates on loans. Once in place, a debt consolidation plan stops debt collection agencies from calling (assuming the loans they call are paid off).
There may also be a tax benefit. The Internal Revenue Service (IRS) does not allow you to deduct interest on unsecured debt consolidation loans. However, if your consolidation loan is covered with an asset, you may be eligible for a tax deduction. Debt consolidation loan interest payments are usually tax deductible when there is equity.
A consolidation loan can also have a positive effect on your credit score later. “If the principal is paid faster [than it would have been without the loan], the balance will be paid earlier, which helps to increase your credit score,” says Freeman.
How debt consolidation works
For example, say that a person with three credit cards and a total of $ 20,000 is due at a monthly interest rate of 22. 99%, who has to pay $ 1047 a month. 37 months per month for 24 months to zero the scales. This amounts to $ 5136. 88 is only paid in interest. If the same person merged those credit cards into a loan with a lower interest rate at an annual interest rate of 11%, he or she would have to pay $ 932. 16 months per 24 months to zero the balance. This amounts to $ 2, 371. 84 is paid in interest. The monthly saving is $ 115. 21, and during the term of the loan, the amount of the saving is $ 2, 765, 04.
Even if the monthly payment remains the same, you can still make progress by streamlining your loans. Suppose you currently have three credit cards that calculate an APR of 28%; they are up to $ 5,000 and you spend $ 250 per month on the minimum payment for each card. If you would pay each credit card separately, you would spend $ 750 per month for 28 months and would have to pay a total of about $ 5,441.73 interest. However, if you settle the balances of those three cards in one consolidated loan at a more reasonable 12% interest rate and you continue to repay the loan at the same $ 750 per month, you pay about a third of the interest ($ 1 820.22), and you can have your loan retired five months earlier. This amounts to a total saving of $ 7, 371, 52 ($ 3, 750 for payments and $ 3, 621, 52 in interest).
Find a debt consolidation loan
If you have a good payment history with a bank, credit association or credit card company, you should ask that institution for a debt consolidation loan, your first step. “If you can ensure that your bank approves a loan, that’s good,” says Tim Gagnon, assistant assistant accountant at D’Amore McKim School of Business at Northeastern University. “But your bank may not intend to keep you as a customer and your credit scores may not be high enough to meet their credit requirements.”
If you are refused by your bank or credit association, Gagnon suggests exploring private mortgage companies or lenders. “They are generally less rigid on scores and proportions.”
How to consolidate debts
Once you have installed your debt consolidation vehicle, how can you decide which bill to tackle first? This can be decided by your lender, who can choose the order in which creditors are repaid.
If not, you should first start paying off your highest interest debt, but if you have a loan with a lower interest rate that causes you more emotional and mental stress than those with a higher interest rate (such as a persuPumpty Dumptyijke loan that family relationships), you better start with that.
Move the payments to the next set in a waterfall payment process once you have paid off debt all your invoices will be repaid.
There are several pitfalls that consumers must consider when consolidating debts.
Extension of the loan period
Your monthly payment and interest rate may be lower thanks to the new loan. But pay attention to the payment schedule: if the content is ally longer than that of your previous debts, you can pay more in the long term. Most credit consolidation providers earn their money by extending the term of the loan to at least the average, if not the longest, term of the borrower’s previous debt. This allows the lender to make a decent profit even if he calculates a lower interest rate. Example: John has $ 19,000 in credit card debt, a car loan of $ 12,000 and $ 5,500 remaining on a school loan. His total monthly payments are $ 1, 175. A debt consolidation provider offers to roll his loans into a single account that a calculates lower interest and lowers his monthly payment to $ 850. He gratefully accepts and saves $ 325 per month. However, the longest term for John’s previous loans was five years and the new loan has a term of 90 months (seven and a half years). He will eventually pay a total amount of $ 6, 375, while with the old debts the maximum he would have paid would have been $ 5,875.
That is why doing your homework is important. Call your credit card issuer (s) to find out how long it would take to pay the debt on each of your cards at the current interest rate. Then compare that with the duration and costs of the consolidation loan you are considering.
To damage the credit score:
By converting your existing loans into a brand new loan, you will probably see Humpty Dumptyijk first having a modest negative effect on your credit score. Credit scores prefer longer-term debts with longer, more consistent payment histories. The replacement of debts before the original contract would have been requested is assessed as negative. You are also listed as a larger, newer debt, which increases your risk factor. And, just like with any other type of credit account, a missed payment goes on a debt consolidation loan on your credit report. Closing the old credit accounts (as soon as they are paid off) and opening a new one can reduce the total amount of credit available to you, increasing your debt / credit usage figure. This can also be your credit score, because lenders may see you with an increased ratio as less financially stable. However, if you consolidate credit card debt and ultimately improve your credit utilization ratio – that is, the amount of potential credit you actually use – your score may increase later.
Example: Sally throws $ 16,000 in credit card debt into a new loan. She cuts open her credit cards, but leaves the bills open. If she has no other debt, she has effectively halved her debt / credit ratio because she now has $ 16,000 in unused credit available on her credit card accounts plus her $ 16,000 consolidation loan. However, if she closed her old bills, she would use 100% of the credit she has available on her new loan, which would have a negative impact on her score.
Jeopardizing assets: Humpty Dumpty is easier to get a secured consolidation loan than an unsecured consolidation loan, which means that you may be able to consolidate multiple unsecured debts (such as your credit card balance) into a larger secured debt. You can pledge your property as collateral at much larger amounts than you had previously. For example, if you use a home loan or credit line, you run a risk for your home if you do not make the required payments. Losing special conditions or benefits:
Student loans have special provisions (such as interest discounts and discounts) that disappear if you consolidate them with other debts. Those who do not receive standard consolidated school loans usually receive their tax refunds and can even have their wages fixed. Pay a lot of money to a debt consolidation service:
These groups often charge substantial initial and monthly costs. And maybe you don’t need them. You can consolidate your debt yourself for free with a new person-to-Humpty Dumpty loan from a bank, or a credit card with a low-interest rate, for example. The bottom line
Replacing multiple loans with multiple rates with one monthly payment with fixed interest certainly makes life easier. Don’t just consolidate for convenience. Unless you are absolutely overwhelmed by multiple payment dates, the convenience of a single monthly payment is not in itself a sufficient reason to consolidate debts, given the pitfalls.
And remember: only consolidating debts won’t get you out of debt; improving spending and saving habits do. If you do combine your debts, resist the temptation to re-generate credit on your credit cards; otherwise you will be burdened with paying them back
and the new consolidated loan. Consolidation is a tool to help you get out of the debt-laden doghouse, not to get a nicer, more expensive doghouse.