Should I Consolidate My Debt? What You Need to Know

Debt can be a very powerful tool you can use to invest in your future — whether that's through education, assets, or even business ventures. Unfortunately, the amount you owe on your various debts can quickly grow out of control if you don’t closely manage your accounts. If you find yourself paying several different credit cards or loans each month, you may consider using a loan calculator to guide your debt pay down or debt consolidation as a strategy to pay off your debt.

While going into debt can sometimes be necessary, relieving yourself of debt that has a become burden can can also sometimes help to improve your finances overall. When you consolidate something like your credit card debt and your student loans, you enable yourself to pay off all your debts sooner. And because interest adds up, paying over a shorter period time can lower the overall amount you pay. In addition, having less debt means your credit score may increase.

So whether you’re interested in credit card debt consolidation, or simply want to make a single payment each month, we’ll get into how to determine if consolidating your debt is right for you and the steps you’ll need to take to do so below.

What Is Debt Consolidation?

 

When you consolidate debt, you’re essentially lumping everything you owe to various entities into a new loan. Usually after you have consolidated your debt you’ll only be making one payment every month at a lower interest rate than before. Debt consolidation is a way to re-organize multiple bills and move the debt owed from a high interest credit card to a lower interest rate loan. Debt consolidation may also be useful when you want to reduce the amount of time spent paying a loan or if you feel that your monthly payments are currently too high.

The main way to consolidate debt is through taking out a low interest rate loan through a lending institution, and using that loan to pay off most or all of your high interest debt. Often if the amount owed is large enough you will need to offer some form of collateral to qualify for the loan, like a house or car. The general rule of thumb for whether you should consolidate your debt, is if your debt does not exceed 50 percent of your yearly income. Debt consolidation will not be as effective if your debt exceeds half your income, and you may want to consider debt relief instead. However it is a good idea to talk with a credible financial advisor to determine the best strategy for you.

Aside from reducing the total amount you will pay, debt consolidation could also help your credit score in some cases. One of the things that your score is based on is debt utilization ratio, or the amount you owe out of your available credit. Most advice says that a utilization ratio below 30 percent is ideal for keeping your credit score healthy.

3 Things to Consider Before Consolidating Your Debt

 

Of course, debt consolidation can take many forms, and you should carefully consider all options and resources available to you before committing to a consolidation plan. Sometimes a better option for dealing with your debt is working with a financial advisor on a debt management plan or settling your credit card debt. Here are some things you should think about before committing to a debt consolidation plan:

1. Look Into All Your Options

Consolidating debt may work better if you have a good credit score or collateral to offer. If you have neither of these, you can consider exploring other strategies to see if there's one that makes sense for you. A simple tip that can help to improve your financial standing is making a budget of your expenses each month to figure out if you can afford to be paying more monthly. Some recommend paying off the debt that you owe the least on in order to be free of the interest on that amount as quickly as possible. You can also work with a credit counselor who can negotiate on your behalf for a debt management plan that works for you. There are many different options depending on your situation, so be sure to do your research.

2. Check the Math

Make sure that the new loan and term length actually work out to a lower amount. The rate of the loan will depend on several factors, including your credit and is up to the financial institution's discretion. While it may make sense to go for a lower monthly payment or interest rate, these things both tend to increase the amount of time you’re paying a loan, which is the biggest factor in determining how much you pay overall. The goal is to pay off the debt as quickly as possible and keep the total amount spent low. If you simply must make the lowest payments per month possible, you may want to speak to a financial adviser about options like settlement.

3. Address Behaviors That Caused the Excessive Debt

Of course, eliminating your debt won’t do any good if your habits get you back into debt just as soon as you get out of it. If you’re in a lot of debt now, consider assessing your financial habits. Some common causes of debt that aren’t often considered include not creating a budget, yearly inflation, and unexpected medical expenses. Unexpected expenses that often get put on credit cards can be mitigated through keeping a savings account and planning out a budget that keeps in mind how prices increase year over year.

How to Consolidate Your Debt in 4 Simple Steps

 

After you’ve decided that consolidating your debt is your best debt reduction strategy, it can be intimidating to figure out how to go about consolidating your debt. But it is a relatively easy if you know what steps to take. Just being aware that you need to make a change can help  put you well on the path to being debt free. Here are the next steps to consolidating your debt:

1. Get Familiar With Your Finances

You’ll need to know exactly what you owe, what you can afford to pay, and what your credit standing is before you can proceed. You’ll need to add up all your debts and their various rates to determine how much of a loan you’ll need and at what interest rate in order to secure one that actually helps you. Next, figure out how much you can put towards paying down your debt each month after all of your other bills. Finally, you’ll need to check your credit score and assess how much your assets are worth for a potential loan.

2. Choose a Consolidation Option

There are several consolidation options depending on how you finances look. You can get loans based on credit, or take out a home equity loan or a life insurance loan. Depending on your credit score and collateral, you may choose not to apply for a loan at all. You can also consider transferring your debt from a higher interest credit card to a lower interest one, which is known as a balance transfer. This works best when you can pay the debt off during the typical 12-18 month offer period. Finally, you can also consider borrowing money from friends and family. This can be a good option when you cannot qualify for good interest rates, but you know that you will be able to pay them back. When choosing consolidation options, its best to consult with an advisor before making any decisions

3. Pick an Institution and Apply for a Loan

If you decide to take out a loan to consolidate your debt, shop around and compare the interest rates and loans to make sure you’re getting the best rate you can qualify for. You’ll have to add up the interest rates, fees, and length of the loan to determine which offers the best deal. Some institutions will give you a quote that won’t affect your credit, so you can get as many as you need. When applying for loans, be wary of any deal that sounds too good to be true. Look into each company’s ratings to make sure your consolidation company will be a credible partner.

4. Pay Off Your Debt and Manage Your Finances

Once you have a plan, it's easy to stay on track and pay off your debt. Be mindful to make your payments on time, as consolidation loans can have high penalties for making late payments. Once you’ve paid off your debt, the very last step is an ongoing one: keep making smart choices about where you spend your money and do your best to save more money than you spend.

Debt consolidation can be a useful strategy to help you manage your finances. By combining several different kinds of debt into one payment at a lower interest rate, this method can help you to become debt free more quickly and pay less each month in some cases. What's more, when you reduce your debt, your credit score can also be positively impacted. Managing your debt through debt consolidation can allow you to qualify for some of life’s most important purchases and can help you gain financial freedom.