Debt consolidation means to obtain a new loan to pay off a number of smaller loans or bills that you are currently working to pay off. It brings all your debts together into one combined loan and allows you to make one monthly payment to cover the amounts and interest owing on your debts.
It brings all of your debts together into one combined loan with one monthly payment by getting you a larger loan to cover the amounts and interest owing on your debts.
It may seem counterintuitive to borrow more money to pay off the money you owe but when you find yourself struggling to manage your debts, there are many advantages to doing so.
Take a look at the advantages of debt consolidation so see if this is the right solution for your financial troubles:
The Advantages of Debt Consolidation
1. It Streamlines Your Debts
Because debt consolidation combines multiple outstanding debts into a single loan, it reduces the number of payments as well as the interest rate.
This means that your credit will improve by reducing the changes of late payments or missed payments.
Plus, you’ll know exactly when your debts are paid off!
If you have multiple credit balances, streamlining your finances and your debts will eliminate multiple payments and make the process of paying them off easier.
2. It May Pay Off Your Debt Earlier
Even though debt consolidation can lead to extended loan terms, you’re saving money from reduced interest rates. This means that you can make extra payments and quickly pay off your debts.
Not only can you pay your debt off earlier but you will also save more on the interest over time.
Think about each credit card or loan you owe money on – it could take years of minimum payments to have them fully paid off. Debt consolidation takes multiple factors into consideration such as your income, credit score, and how much you owe in order to create a realistic payback plan.
So when you take that into consideration, along with the opportunity to make extra payments, debt consolidation loans have an overall shorter payback period.
3. It Can Lower Your Interest Rate
We mentioned how debt consolidation can lower your interest rate, but let’s look at this advantage in more detail.
Even if most of your debts have low interest rates, a short-term debt consolidation plan can save you money on interest rates over the life of the plan.
However, most unsecured debt (such as credit cards) have high interest rates that add a significant amount to your monthly payments. When you pay off multiple high-interest debts in one go, you can secure a lower interest rate based on your credit score.
Even if your credit score is low, there’s a high chance that the interest rate on your debt consolidation loan will be lower than what you are currently paying.
4. It Could Reduce Your Monthly Payments
Along with saving on interest costs due to lower rates, the overall monthly payment on a debt consolidation loan is likely to decrease as well because the payments are spread out over a longer period of time.
This means that, by making the minimum payments, you can improve your cash flow which can then be added to the debt to pay it off quicker or put away into a savings account for your future.
5. It Can Help Improve Your Credit Score
There are a lot of factors that come into play when it comes to owing on debts. Not only is it a stressful situation but falling behind on payments will negatively impact your credit score, lowering your chances of borrowing money in the future.
Debt consolidation rolls all of your debt into one loan which means you can quickly pay off revolving lines of credit such as credit cards. This reduces the credit utilization rate that is calculated into your credit report.
The credit utilization rate looks at the percentage of your total available credit currently being used. Ideally, your credit utilization rate should be under 30%.
For example, if you have $5,000 in credit still available on a credit card and your balance is at $1,500, your credit utilization rate would be at 30%.
Making consistent, on-time payments on your debt consolidation loan keeps your rate at a healthy percentage and can improve your credit score.
However, it’s important to note that whenever you acquire new credit you will notice a temporary dip in your credit score. Fortunately, the long-term benefits of debt consolidation will improve your credit rating.
6. It Can Help Reduce Your Stress
Again, owing on debts you can’t pay is a stressful situation – especially if you owe on multiple debts. Between the stress of owing money and trying to organize your payments, it can create a heavy burden on your life.
Consolidating your debt into one manageable payment helps reduce the clutter of multiple payments, both from your bank account and from your mind.
Debt consolidation allows you to take control of your finances and stay on top of your debts.
How is Debt Consolidation Different From Bankruptcy?
Where debt consolidation involves taking out a loan to cover the debts you owe, bankruptcy is a legal process that eliminates your debt completely.
While bankruptcy may seem like an ideal solution to problems with debt, it is a matter of public record and could involve surrendering assets. It also impacts your credit report for at least six years.
There are financial situations in which bankruptcy is appropriate but it’s important to understand the difference between debt consolidation and bankruptcy before committing to either debt-relief tool.
Is Debt Consolidation Right For Me?
There’s no way to know for sure if debt consolidation is right for you unless you speak with a Licensed Insolvency Trustee (LIT).
Our LITs at Frederick & Company Ltd. are trained debt relief advisors who are passionate about helping people understand and find solutions to their financial troubles.
With our knowledge, we can help you determine if debt consolidation, or any of our other debt-relief tools, is the right choice for you.