If you’re tired of paying multiple creditors each month, debt consolidation could work for you. It streamlines the repayment process and could save you hundreds or thousands of dollars in interest. You could also meet your debt payoff goals faster.
But how does it work? And are there other more effective alternatives to help eliminate your unsecured debts? This guide dives into the debt consolidation process, key benefits, and other options that may be a better fit.
What Is Debt Consolidation?
Debt consolidation combines several debts into a single product to streamline the repayment process. Instead of paying multiple creditors, you only make one payment to a single creditor each month.
What is a Debt Consolidation Loan?
A debt consolidation loan is a personal loan marketed by credit unions, online lenders, and banks as a smart way to manage outstanding debts. It’s unsecured, so you won’t need to put up collateral to qualify.
If approved, you receive a lump sum that’s repayable in monthly installments. Plus, the interest rate is fixed, so your monthly payments won’t change.
You’re free to use the funds however you see fit, but the idea is to pay off your high-interest debts and enjoy a smaller monthly payment to one creditor instead of several. Plus, you could save a bundle in interest and pay off the balances quicker, assuming you don’t use the credit cards again.
How Does Debt Consolidation Work?
If you have good or excellent credit and a steady source of income, you could get approved for a debt consolidation loan with a competitive interest rate. Here’s an overview of the process:
- Step 1: Complete an application with the lender and provide requested documentation.
- Step 2: The lender reviews your application, credit score, and credit report to determine your debt-to-income ratio and if you can afford monthly payments.
- Step 3: You receive an approval or denial. If approved, the lender forwards loan documents to you for review.
- Step 4: Sign on the dotted line and receive your loan proceeds.
Some lenders process debt consolidation applications and disburse funds in just a few days, while others take several weeks.
Should You Consolidate Your Debt?
Debt consolidation could be ideal if you can afford to make your monthly debt payments but would like to expedite the payoff process. It’s equally vital that you have good or excellent credit to qualify for a competitive interest rate.
However, debt consolidation may not suit you if you’re financially distressed and find it challenging to cover basic necessities. If you’re behind on your payments or have credit issues, you may want to consider other options.
Have a small amount of debt you’d like to consolidate? Formulate a plan of action to eliminate it quickly to avoid paying a loan origination fee and interest that comes with a debt consolidation loan.
The Benefits of Debt Consolidation
There are several advantages to consolidating your debt.
Lower Monthly Payments and Interest Charges
With good or excellent credit, you’ll likely receive a lower interest rate than what you’re currently paying on your debt. Consequently, your monthly payments could be lower and more affordable. The lender may also offer extended repayment periods, which means you’ll have longer to pay and can reduce your monthly payment even more to keep more of your hard-earned money in your bank account.
Easier Payment Schedule
Struggling to keep up with due dates for your debts? Or maybe you’ve been late on more than one occasion and hit with a late fee, penalty APR or a negative mark on your credit report? Debt consolidation helps alleviate this issue by simplifying the repayment process.
Potential Credit Score Improvement
The amount you owe creditors accounts for 30 percent of your credit score. If you use a debt consolidation loan to pay off credit cards, your utilization ratio (or the amount of your credit line in use) will decrease and possibly help your credit score.
Debt Consolidation vs. Debt Settlement: What Is The Difference?
Debt consolidation and debt settlement are two methods consumers use to find relief from overwhelming credit card debt, but they aren’t quite the same.
When you settle your debts, you pay creditors a fraction of what you owe, which could have serious implications for your credit. And instead of receiving a lump sum to repay creditors, you contribute to a dedicated account each month. The funds are used to repay creditors each time a settlement is reached.
Another glaring difference between the two is costs. Debt settlement companies don’t charge interest because they aren’t loaning you anything, per se. However, you are assessed a fee each time an account is settled. But with a debt consolidation loan, you will generally pay a loan origination fee, and interest is included in the monthly payment.
How to Get a Debt Consolidation Loan
Debt consolidations loans are available in abundance, but not all products are the same. So, you want to research lenders and use pre-qualification tools to gauge which can offer you the most viable options.
