Debt consolidation can help borrowers save money and simplify their repayment plans. This is especially true for those who have debt with multiple creditors with various interest rates.
When debt consolidation is planned and performed correctly, it can help borrowers pay off their debts quicker and with ease. Consolidating debt might be a good option for those whose total debt is not greater than half of their current income. Furthermore, their credit scores must be high enough for them to qualify for low interest debt consolidation or a zero percent interest rate credit card.
Debt consolidation can be an effective way to re-establish good credit when done properly. This is as long as a borrower earns enough income to meet the minimum monthly payments and the debt consolidation plan keeps them from accumulating a high amount of debt in the future. However, debt consolidation plans are not the right option for everyone. In some cases, it can be more harmful than helpful. Read the information below to determine if debt consolidation is the right option for you nad your financial situation.
How does debt consolidation work?
Debt consolidation involves taking balances from high-interest bearing debt accounts from the numerous creditors they belong to and combining them into one single debt under one creditor with a lower interest rate. Doing this can decrease borrowers’ monthly payments. On credit reports, the debts owed to various creditors would be marked as charged off. Then, there would only be one credit account with a debt consolidation creditor. This will result in a positive effect on borrowers’ credit scores as long as they keep the account in good standing. Residents can go about consolidating their debts in one of two ways:
- Fixed-rated person loan – Residents can take out a personal loan with their bank or creditor at a low, fixed rate. Then, they can use those available funds to pay off their multiple sources of debt. Borrowers will then only need to pay back the funds for the personal loan.
- Complete a balance transfer to a zero percent interest credit card – For this method, borrowers will need to find a credit card with a zero percent interest rate. They can usually find this through a promotional sign-up offer. This promotion must apply to balance transfers but will be beneficial if it applies to purchases as well. Borrowers can transfer all of their debts to this card and pay the full balance before the promotion expires.
Besides the most common methods, there are other ways that residents can consolidate and pay off their debts. For instance, debtors can take out a loan on their 401(k) retirement plans or on their home equity. However, taking out these kinds of loans can be risky to either retirement savings or residents’ homes. Borrowers should consider all of their options and the factors involved before taking out a new debt to consolidate existing debts. This decision should be one that is beneficial to borrowers’ financial circumstances and future.
What are the benefits of debt consolidation?
As previously mentioned, one of the most useful benefits of debt consolidation is that it can help debtors pay a lower interest rate on their consolidated debt. However, there are other benefits associated with debt consolidation. For instance, consolidating debt can make it easier for residents to pay off their debts while positively impacting their credit scores. With debt consolidation, residents only have to make a single payment on their debt once per month rather than several on various due dates. This can help simplify finances and prevent defaulting and late payments.
Consolidating multiple sources of debt can help residents pay off their debts faster. This is because borrowers will be able to pay more towards their principal each month instead of towards various interest traits on multiple accounts. Paying toward the principal helps to pay off debts sooner. When regular payments are made toward the principal, the interest rate decreases. Thus, the interest rate on new balances will continually decreases and borrowers will pay less for their debt each time.
Considering Your Credit Score
Consolidating debt can be beneficial for borrowers’ credit scores. However, there are some potential risks involved for those who are consolidating their debts. Even borrowers who comply with the terms and conditions of their debt consolidation agreement, their credit scores can still be negatively impacted in several ways. For instance, creditors who look up the borrower’s credit history to determine if he or she should be given credit will see that they are participating in a debt consolidation plan. This may negatively affect their credit score. This is because whenever a new form of credit is taken out, the average length of total credit history is reduced. Thus the borrower’s credit score is reduced even if they are properly managing their debts.
Furthermore, whenever residents close a credit account, their credit score is affected as well. This is because the amount of credit accounts open to the number of total credit available impacts credit score. To avoid a decrease in credit score, borrowers should keep their credit accounts open until they have been charged off through debt consolidation. Moreover, keep in mind that credit scores can also be impacted by the scoring method that is used.
When is debt consolidation a bad idea?
Consolidating debt may not be the right decision for everyone although there are many benefits to combining different sources of debt. For example, some borrowers do not have the discipline or control to manage their spending habits. These debtors may temporarily get out of debt but it may not be a good long-term solution. In addition, those who have little discipline to make regular payments may not benefit from a debt consolidation plan. Moreover, debtors who do not earn an adequate income to pay off single, small, reduced interest loans also may not benefit from consolidating their loans. Those have a small amount of debt and believe that they can manage paying off their debt in six months to one year at their current rate are in a good position to repay their loans and get out of debt fast.
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