Debt consolidation loans take multiple debts and combine them into one (with a single, easy to manage, and budget-friendly interest rate). There are many advantages to this, and for many people, it can be a life-save that helps them manage their finances and get out of or recover from debt. In this post, find out more about how debt consolidation loans work and how you can use them to your benefit.
Debt Consolidation Loans: What Are They?
Debt consolidation loans essentially combine high-interest debts, such as credit card bills, into a single, lower-interest payment. That said, if you have overwhelming debt, are struggling to make the payments on multiple loans or credits, or (even) have bad credit, a debt consolidation loan can help you manage your finances, and pay off you total debt faster.
Consolidating your debt is a good way to roll all of your outstanding debts into one, convenient payment while also restructuring your payments. This offers the opportunity to pay off your debts more quickly while saving you money in the long run, since consolidation loans typically have lower interest rates than run of the mill credit cards.
And since debt consolidation loans come with predetermined term–many people can determine when they’ll pay off their loan–making it easier for them to manage their spending, keep track of their payments, make them on time. While making minimum payments on multiple credit cards could mean months or years before they’re paid off, (all while accruing more interest) debt consolidation loans allow people to pay off their debt within a manageable time frame.
How Do Debt Consolidation Loans Work?
There are two primary ways of consolidating your debt:
- 0% interest credit cards that allow you to transfer all of your debts to a single card, then pay off the full balance during the promotional period, while the interest rate is 0%.
- Getting a fixed-rate debt consolidation loan to pay off your debt, then pay back the loan in installments over a set term.
Alternative pathways include:
- Taking out a home equity loan, which uses the equity on your home as collateral for your loan. (While this seems like a good option, the risks are high. If you default on the loan, you could lose your home.)
- A fourth option is a 401(k) loan. This allows you to borrow up to half of the money you have saved for retirement (using your savings as collateral), with the obvious risk that if you cannot pay it back you lose half your retirement savings. (Another seemingly good, yet high risk, option).
- Working with a professional loan advisor can help you determine if you are eligible for a debt consolidation loan and, if so, what is the best route you should take to secure one that benefits you and your budget.
Am I Eligible?
Debt consolidation loans have low interest rates, but you need to have a good credit score to qualify for them. You also should have a manageable amount of debt. For debt consolidation to be a good idea, your total debt (excluding your mortgage) should not be more than 40% of your gross income. If your debt is higher than that, debt consolidation may not be for you, as you may not qualify for a loan with a low enough interest rate for it to be worth it.
An ideal debt consolidation scenario involves having multiple debts- credit cards, student loans, and a mortgage- with high interest rates. If you make all your payments on time, you will have good credit. However, keeping track of all of those payments is difficult, and the interest rates are high enough that making the minimum payment on each will have you paying off the debt for years.
In that case, if you are able to qualify for a consolidation loan with an interest rate of 10% or less you can save a lot of money. If you do not include your mortgage in that loan, you can get something short, such as a 3 or 5 year loan, which can help by giving you a short time-frame to pay off all of your debt on time.
When Debt Consolidation Loans Are A Good Idea
Consolidation loans offer much lower interest rates and better payment plans than most credit cards, car loans, and even many student loans or mortgages. This means that if you have manageable debt (meaning, that your debt, excluding mortgages and student loans, is less than 40% of your gross income) and you aren’t missing payments, debt consolidation is a smart way to save money and pay your debts off quickly.
For more information on debt consolidation loans, or loans in general, contact Fairfax Mortgage Investments. Fairfax has been helping people with debt consolidation, mortgages, and other financial services for over four decades, and their experts are ready to help you too!