Debt consolidation explained – how do debt consolidation loans work for you?
Everyone needs a little help wrangling their finances from time to time. With so many different bills, credit cards, and loans to worry about, keeping track of your bills and paying everything on time can be a tough task.
While you could try to repay individual bills or debts separately, there's another potentially better option for paying off your debt: debt consolidation.
Debt consolidation loans are some of the best debt management tools available. These types of loans can help you manage multiple debts by combining several loan balances into a single new loan that’s far easier to repay.
So, just what are debt consolidation loans and why should you use them? Let’s break down both of these questions and more.
What is debt consolidation?
Debt consolidation is a debt management strategy that involves taking out a debt consolidation loan and using that cash to pay off other, separate debts. Using a debt consolidation loan, borrowers can more easily pay back larger amounts of debt than if they had to juggle multiple bills simultaneously.
So, where can you get a debt consolidation loan? Debt consolidation loans are offered by certain financial institutions such as Regional Finance.
How do debt consolidation loans work?
In a debt consolidation loan, a borrower takes out a loan in an amount that totals several other existing bills. The new loan is used to pay back those separate debts to credit card companies or other lenders.
Here’s an example of how debt consolidation loans work:
- Bob applies for a credit card and uses $500 of its credit line. Bob also has an auto loan of $1,000, a medical bill for $700, and another loan for $200.
- Combined, Bob’s debts total $2,400. There are four bills Bob has to worry about.
- Each of the bills/debts has its own high interest rate, monthly minimum payment, and potential fees. Naturally, managing all these high interest debts can be very stressful.
- Bob takes out a debt consolidation loan. The lender gives Bob $2,400, which is then used to pay back the four other bills entirely. The debts are cleared, and Bob no longer needs to worry about their fees or rising interest rates.
- Now, Bob has a single personal loan of $2,400 with one fixed interest rate and one monthly billing cycle. It’s a lot easier for Bob to pay back this one bill, rather than multiple individual bills with fluctuating interest rates.
A single consolidation loan simplifies your monthly bills, giving you peace of mind.
Benefits of debt consolidation
Debt consolidation loans are popular choices for folks who need a little help managing multiple bills for a variety of reasons. The benefits of debt consolidation loans include:
- Low fixed interest rates. Most debt consolidation contracts have low interest rates relative to the interest rates you might see on other bills or credit card balances.
- Fewer interest rates accruing at the same time. Since you only pay a single bill, you don’t have to pay different interest rates on multiple loans.
- Easier tracking for bill due dates. It’s easier to make loan payments for a single debt consolidation loan than to pay back multiple bills that may have different due dates or billing cycles.
- Want to improve your credit score? A debt consolidation loan can help you do just that! Paying off your other loans entirely and making regular monthly payments on a debt consolidation loan can do wonders for showing the major credit bureaus you are a responsible borrower. This could eventually lead to higher credit limits and better loan offers. To benefit from all these advantages, however, borrowers must use the money from their debt consolidation loan to pay off their existing debts immediately.
Downsides to debt consolidation
While debt consolidation can be an excellent choice for many, there are a few downsides to keep in mind as well.
Many debt consolidation or personal loans come with upfront costs, including loan origination fees and balance transfer fees. It's important to check the terms of a debt consolidation loan just like you would with a regular loan.
Additionally, there’s no guarantee that a debt consolidation loan will have a lower interest rate than the interest rates of your other debts. You should read the fine print of a debt consolidation agreement before signing on the dotted line to make sure you’re getting a good deal.
Other debt management strategies
Debt consolidation is not the only way to manage multiple bills or loans if you’re having a little trouble. After all, a debt consolidation loan may not be useful if you only have a single loan to pay off. There are other options that can help you in creating a debt management plan.
One of the most common alternatives to debt consolidation is credit card refinancing. If an individual has a credit card balance that is too tough to handle, they can try to refinance their card’s balance by transferring that balance to a new card.
In credit card refinancing, cardholders can move the balances from one or more other credit cards to a single credit card that has a zero interest “grace period.” During this grace period, the cardholder doesn’t have to worry about any interest accruing on the balance they put on the card. In most cases, the grace period is between 12 and 18 months.
Here’s an example of how credit card refinancing works:
- Alice has three credit cards with balances of $200, $300, and $700 each. They total $1,200 in credit card
- She transfers the debts from all three credit cards to a new, zero interest credit card. Then she can focus on paying down the $1,200 on one credit card with a single bill without worrying about interest accruing each
Debt consolidation vs. credit card refinancing
There are a few downsides to credit card refinancing. For example, most cards that allow balance transfers incur transfer fees of between 3% and 5% of the total balance amount. In the above example, this would be between $36 and $50.
Furthermore, many cards that have zero interest grace periods also have high regular interest rates. To make the most of credit card refinancing, you must pay off your debts before the grace period ends. Because of this, credit card refinancing is only a good strategy if your credit card balances aren't very high.
Are debt consolidation loans right for you?
In the end, only you can decide whether a debt consolidation loan is the right choice for your unique financial situation and budgeting goals.
The information and materials provided on this website are intended for informational purposes only and should not be treated as an offer or solicitation of credit or any other product or service of Regional Finance or any other company. This website may contain links to websites controlled or offered by third parties. We have not reviewed all of the third-party sites linked to this website and are not responsible for the content, products, privacy policy, security, or practices of any linked third-party website. The inclusion of any third-party link does not imply any endorsement by Regional Finance of the linked third party, its website, or its product or services. Use of any third-party website is at your own risk.
References accessed on July 10th, 2021:
Credit.com – What Exactly is a Debt Consolidation Loan?
