Becoming debt-free can be quite a ride. There are several ways to get there, and debt consolidation is one of them.
What is debt consolidation?
If you are juggling several loan repayments each month, this might be worth a look. Debt consolidation lets you merge different debts into one loan with one monthly payment. Debt refinancing is a related option, where you replace a single debt with one on better terms, such as a lower interest rate or smaller monthly payments.
Let’s see whether it fits your situation, because it comes with both benefits and drawbacks.
Benefits
- Convenience: all your debts in one place and one payment a month. No more mixing up accounts or missing payments.
- Smaller monthly payments, which improve your monthly cash flow.
- A lower interest rate: if your current debts have high interest, a cheaper loan can save you money.
- Paying off debt sooner: if you get a lower rate and keep paying about the same amount each month, you can be debt-free earlier.
Drawbacks
Debt consolidation can lead to unhealthy habits. Smaller payments can make you feel so relieved that you forget what got you into debt and keep overspending.
A lower monthly payment often comes from a longer loan. Stretching the loan out can mean you pay more interest in total, even at a lower rate. Watch for fees too, such as origination fees or penalties for paying off your old loans early.
Don’t let consolidation become a trap. Make an action plan to get back on track and use consolidation as a tool on your way to being debt-free. It is a good servant but a bad master. Don’t use it just to make life easier for a few months and end up deeper in debt.
Create your debt overview
In a nutshell, debt consolidation means paying off your smaller loans and debts with one new, bigger loan. These steps will help you see your situation clearly:
- Make a table of all your debts.
- For each debt, add the total amount owed, the due date and the interest rate.
- Add up the total you owe. This is how much you would need to consolidate.
- Add up all your monthly payments. You will compare this with the consolidation loan.
- Consolidation loans are usually offered by banks, credit unions and other lenders. Ask them about the conditions, interest rate, fees and monthly payment.
- Compare your current monthly payments and total cost with the new loan. Think through your own situation and all the pros and cons.
Usually, you need to decide whether smaller monthly payments are worth staying in debt longer or paying more overall. That is not always the case, but check the details and the impact (for example on your credit score) with a financial advisor before you sign.
Whatever you decide, a budget is the most effective way to control your spending. It helps you free up money to repay your loans sooner.