Have you ever felt buried in all the statements — paper, electronic or both — you receive every month from your creditors? If so, you’re not alone; the average American with at least one credit card actually has closer to four cards. Do you feel like the payments you’re making each month are barely making a dent in your debt because interest just keeps growing? Debt consolidation is a strategy that aims to address these challenges by simplifying the repayment process and lowering the amount of interest you’ll pay over time.
Here’s a general overview of what to expect from the debt consolidation process.
Strategy #1: Debt Consolidation Loan
There are three primary ways to approach debt consolidation, each with its own set of pros and cons. Comparing these methods and choosing whichever will serve you best is the most effective strategy.
The first way people can consolidate their debts is with a personal loan. These are available through banks and credit unions as well as debt consolidation programs. The idea behind taking out a loan is that you may be able to secure a lower interest rate than you’re currently paying on high-interest debts like credit cards — and you’ll only have to make one monthly payment instead of multiple.
According to ValuePenguin, the average interest rates for consolidation loans vs. credit cards based upon credit scores are:
- Excellent credit (720 – 850): 4.52 – 20.57 percent
- Good credit (680 – 719): 6.67 – 28.33 percent
- Average/Fair (640 – 679): 7.05 – 30.32 percent
- Poor (300 – 639): 15.06 – 36 percent
As you can see, your credit rating plays a significant role in determining the terms of the consolidation loan for which you qualify. The interest rate will also depend on the size of the loan, the lender, your overall financial history and the length of the loan.
If you decide to go this route, you’ll pay off your high-interest debts immediately. You will then pay the consolidation loan in monthly installments.
Strategy #2: Credit Card Balance Transfers
The concept behind balance transfers is pretty straightforward: You move the balance from a high-interest card to one with little to no interest. You’ll pay a fee to do so, usually three to five percent of the original balance, but you’ll buy yourself a break from crushing interest rates — at least until the introductory period on the balance transfer card ends and the interest rates jump back up.
It’s important to use balance transfers responsibly, and only when you have a plan for aggressively paying down your balance during the grace period without interest. Otherwise you’ll end up paying a fee without really gaining any traction on your debts.
Strategy #3: Cash-Out Refinance
This third strategy applies to homeowners with equity only. It involves refinancing your mortgage and taking out the difference in cash, which you’ll then use to pay down your debts. This can help you avoid delinquency and reduce interest rates, as the interest on mortgages tends to be much lower than that charged against credit card balances and medical bills.
The downside is it’ll add years to your mortgage repayment and require expenses such as closing costs. There’s also some risk involved whenever your mortgage is involved because if you fall behind on payments, the lender could repossess or foreclose on your home.
Essentially, debt consolidation involves replacing multiple high-interest monthly debt payments with a single monthly payment at a lower rate. Whichever strategy you choose, it’s important to know the pros and cons before proceeding.