Debt consolidation loans allow you to refinance by taking on a new loan to pay off multiple debts. Consolidation combines numerous debt obligations into one monthly bill that streamlines the repayment process for credit cards, loans, and other bills. Loans are typically paid in monthly installments that include interest and fees accrued. They can be an effective way to resolve debt, but only if you meet specific criteria. Find out if debt consolidation is a good idea for you and your debt.
How to Decide if Debt Consolidation Loan is Right for You
This type of refinancing is best suited to people who have a good credit rating, regular income, and who already practice responsible financial habits. A debt consolidation loan is usually not aggressive enough for individuals with more debt than they can afford, a history of missed payments, or other income insecurities.
Debt consolidation is a good idea if you:
- Have a regular income
- Have a high credit score
- Can pay more than the minimum payment to expedite loan repayment.
A good debt consolidation loan will give you access to better loan terms, like a lower interest rate, so you get more out of your monthly payments.
Debt consolidation may not be suitable for you if:
- If you are low-income and have a poor credit score
- If you have a high income but equally high monthly expenses
If you are low-income and have a poor credit score, it is unlikely you’ll be eligible for a debt consolidation loan with a reasonable interest rate that will save you money. Also, your loan may have a monthly payment that is still too high for your budget. If this is the case, debt settlement might be a better fit.
The Cost of Debt Consolidation Loans
The actual cost of a debt consolidation loan depends on the interest and repayment term. In general, longer terms will cost you more in interest. However, a loan with a short term may have high monthly payments. This will help you pay off the loan faster and have a more significant impact on your monthly budget.
A debt consolidation loan costs may include:
- Origination fees
- Annual fees
- Late fees
- Early repayment fees
The Cost of a Debt Consolidation Loan vs. Debt Settlement
The best way to understand the cost of a consolidation loan is to examine how much is paid in interest over the loan’s life and compare it to the savings in a debt settlement.
*The total repayment amount includes program fees. Fees vary by state and are based on a percentage of your enrolled debt at the time of starting the program and range from 15%-25% of your enrolled debt. Your outstanding debt may increase from the accrual of fees and interest.
Before Apply for a Debt Consolidation Loan, Decide on Your Financial Priority
A debt consolidation loan should always have a lower interest rate than what you were paying before; however, your financial priorities will govern what loan terms are best for you. When applying for a debt consolidation loan, you will need to pick one of two financial priorities.
- “I want to pay less overall on my loan”
- “I want a lower monthly payment”
Priority #1: “I want to pay less overall on my loan”
If you decide to save money and pay less overall for your loan, you should look for a debt consolidation loan with a lower interest rate and a shorter repayment term. In this case, you may agree to a higher monthly payment amount so that you pay off the debt faster.
- A lower interest rate
- Shorter repayment term
- A higher monthly payment that will help you pay off the loan faster
Lower interest rates and higher monthly payments ensure more of your money goes toward paying down the principal balance.
Priority #2: “I want a lower monthly payment”
Alternatively, suppose a lower monthly payment is your top priority. In that case, you’ll need to find a loan with a lower interest rate but a longer repayment term that can significantly lower your monthly payment amount.
- A lower interest rate
- A longer repayment term that can significantly lower your monthly payment amount
In this instance, you may not save as much money on the debt overall, but the loan terms can make it easier for you to manage right now, freeing up cash flow for your other financial obligations.
The Pros and Cons of Debt Consolidation
Debt consolidation loans are a straightforward way to consolidate and pay off debt. Unfortunately, they don’t work for everyone. The pros and cons of this method depend on your circumstances and whether or not a debt consolidation loan can meet your needs and help you get out of debt.
- Combine multiple debts into one
- Works well for people with good credit.
- One simplified monthly payment
- Lenders like banks provide structure in repayment.
- Prioritizes a repayment option that meets your financial needs
- Shorter repayment plan to get out of debt faster and for less interest
- Longer repayment plan to lower your monthly repayment obligation
- Won’t do significant damage to your credit score unless you miss payments
- Not ideal for people with poor credit.
- You must qualify for a lower interest rate to save money
- You are still required to pay interest on your debt
- You save less money than if you were to settle the debt for a much lower amount
- May not relieve your monthly burden if the total amount of the debt is much more than you can afford
- Typically not aggressive enough for people who have more debt than they can afford
An Alternative to Debt Consolidation Loans
Before deciding if a debt consolidation loan is a good idea for you, you should consider all your options. Debt resolution methods are not one size fits. If you don’t meet the criteria for a debt consolidation loan, another option like debt settlement could help.
Debt settlement allows you to save on your monthly payments and pay off debt faster and for less money. Debt settlement is particularly good for people with poor credit scores or who have fallen behind on payments. However, those aren’t the only reasons people choose this method.
Debt settlement could be a good alternative for anyone who wants to:
- Save on monthly payments
- Have experienced a financial emergency
- Are behind on payments; delinquent
- Minimum payment or more is a significant burden
To learn more about debt settlement, you can review your debt with a Certified Debt Specialist. Accredited Debt Relief offers risk-free consultations to folks who are looking to take back control of their debt. Get a free quote.
Weigh all your Options Before Applying for a Loan
Applying for a debt consolidation loan requires a hard credit pull, which can ding your credit score. Before pursuing a debt consolidation loan, make sure you’ve analyzed your eligibility and weighed all your options.
Learn more about the pros and cons of debt consolidations and how to choose the right method.