If you’re overwhelmed by debt, consider consolidating your loan balances. Consolidation can be a great way to get your finances under control, but it’s important to understand the pros and cons of debt consolidation before making a decision.
What is debt consolidation?
Debt consolidation is the process of combining multiple debts into a single debt arranged with one creditor. Debt consolidation is achieved either by taking out a new loan to pay off existing debts, transferring balances to a single credit card account, or using a debt management plan.
Debt consolidation can have several benefits — however, it is vital to consider the potential risks before choosing it as the answer to your debt problem.
Pros of Debt Consolidation
Lower Interest Rates
Consolidating debt ideally means you’ve secured an interest rate that’s lower than the rates you’ve been paying on your existing debts. When you consolidate debt, you essentially take out a new loan to pay off the existing debt. When the new loan gives you a lower interest rate than your individual debts, you may save money over time, depending on how long it takes to pay off the new loan.
One monthly payment
One of the primary benefits of debt consolidation is that it allows you to make just one payment each month instead of making multiple payments with different due dates for each. When you have multiple payments, keeping track of those due dates and minimum payments can be difficult.
Improved credit score
Debt consolidation may help improve your credit score over time. When you consolidate your debts, you should see improvement in your credit utilization ratio (the amount of credit you use compared to the amount of credit you have available) over time.
Cons of Debt Consolidation
You might rack up new debt:
If you consolidate your debts into one loan, you might be tempted to rack up new debt. This can negate the benefits of debt consolidation and leave you in an even worse financial situation than before.
You may lose benefits
Before you consolidate debt, consider whether you might have some debts that might not be suitable for including with the others. For example, if you have a low-interest rate on one (or more) of your debts, consolidating the old loan into a new loan with a higher interest rate could cost you money.
Additionally, if you have a good payment history with one or more of your creditors, consolidating those debts would end that positive history.
The Bottom Line
Overall, debt consolidation can be a helpful way to get finances back on track. If you’re able to successfully lower your interest rates and combine all of your payments into one monthly bill, you’ll probably save yourself time and money. It’s important to be aware of the potential pitfalls, like being tempted to rack up new debt.
However, with careful planning and execution, consolidating debt can be an effective way to regain control over your financial life.