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Anyone who’s been in debt knows that it can seem like a literal burden on you. Whether it’s student loans or credit cards, just knowing you owe a lot can really cost you money.
Fortunately, you can make a difference. (Yes, even you.) Chances are you’ve seen or read stories about how people have paid off thousands of dollars in debt in just a few months. I’ll grant you that the headlines make it seem simple and easy (it doesn’t), but it is indeed possible. Yes, you will have to make sacrifices, be incredibly disciplined, and probably change the way you think about money, but all of these things are doable.
If you have a lot of debt and are looking for a way out, you’ve come to the right place. You can get out of debt, and a debt consolidation loan is an option to consider. Is this a one-size-fits-all solution that will work for everyone? Certainly not. But if you’re struggling to keep up with many different payments each month, or if you’ve been getting killed by interest rates, keep reading. Below, Greg McBride, Chief Financial Analyst of Bankrate, shares five key points to keep in mind when exploring debt consolidation loans. Her advice might be just what you need to make a difference.
5 questions to ask when considering a debt consolidation loan
1. What is a debt consolidation loan?
Let’s start with the basics, right? As the name suggests, a debt consolidation loan is a way to combine several loans into one. It is a fairly common service that many online banks and lenders offer.
Consolidating your debt can have many benefits. First, it simplifies the monthly payments. It’s much easier to pay off a loan each month than it is to keep track of and pay off multiple credit card and / or student loan companies.
Another reason to consider a debt consolidation loan? They could offer a better interest rate. Now be forewarned, this isn’t always the case, but it is definitely worth considering. More to come a little later.
Finally, McBride explains that debt consolidation can increase your credit score. Having more than one credit card at most can negatively impact your credit score because your credit usage is high. If you transfer these loans to just one debt consolidation loan, your overall available credit will increase, and your other card balances will decrease because you used the loan to pay them off. These two factors, along with regular, on-time payments on your debt consolidation loan, can mean a big boost to your credit score.
2. What are the terms of your current loan (s)?
As with any loan, it is important to consider the terms of a debt consolidation loan before deciding if it is the right option for you. One thing to watch out for is the length of loan payments during a debt consolidation. If the payment terms are longer than your current credit cards, then you should work on renegotiating those terms. McBride cautions that you certainly don’t want to take out a longer term debt consolidation loan than the one you currently have.
3. What is the interest rate on your current loan?
Store credit cards have noticeably high interest rates. We are talking about more than 20% in some cases. If you have a lot of debt in this form, a debt consolidation loan might be right for you just to reduce the total amount of interest you pay over time. When considering your options, always check the interest rate on a debt consolidation loan. If it’s lower (even a little) than the interest rate on your current debt, it may be a good thing for you. These small interest rate payments really add up over time, and wouldn’t you prefer that money be in your bank account?
If your debt happens to be student loans, you unfortunately won’t get interest rate reduction with a debt consolidation loan. According to McBride, the debt consolidation loan will have an interest rate that is simply the average of all your current student loans. That said, if multiple student loan payments are painful for you, consolidating them can ease that burden.
4. Will you be approved for a debt consolidation loan?
A debt consolidation loan is like any other; you will still need to be approved for this. (No, just having a lot of debt doesn’t automatically mean you qualify.) With that in mind, you’ll need to consider whether you’re a good candidate for this type of loan. What’s your credit rating? What is your debt ratio or the amount of your monthly income used for loan repayments? Do you have any collateral to offer the lender such as a house or other property? These are all factors that lenders will take into consideration when determining whether or not to approve you for a debt consolidation loan.
If your credit score isn’t good or your debt ratio is high, don’t be completely discouraged. A debt consolidation loan can always be worth exploring, as some lenders are more flexible than others. That said, you may need to make some concessions depending on your situation. If you are not a very strong candidate, some lenders may approve your debt consolidation loan, but rather than giving you the money to pay off all of your other debts, they may stipulate that they pay other creditors directly. After all, they have to be confident that you are actually going to use the money for the intended purpose and also that you will pay them back. Which leads to the last point …
5. Are you really ready to change?
According to McBride, this is arguably the most important consideration. Think about how you have accumulated the debt that you have. If a job loss or medical emergency has put you in debt, you are likely to get back on track once these issues are resolved. If, however, frivolously spending and living beyond your means is the reason you’re in deep debt, you need to sort this out first. As McBride explains, you don’t want to just “move lounge chairs” or, in other words, transfer debt from one lender to another. Yes, the goal of a debt consolidation loan is to make it easier to pay off your debt, but the key to success is actually paying off your debt. The worst thing you can do is use a debt consolidation loan to free up your other lines of credit just to increase them again. Before proceeding with a debt consolidation loan, think long and hard about whether you are ready to tie up and start getting rid of your debt. It won’t happen overnight and it will certainly mean less boozy brunches with friends and new clothes each season, but always keep an eye on the end goal. When you’ve lived so many years buried in debt, being free from that weight will truly make you feel like you can do it all.
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