If debt affects your finances, you could have a share of $ 4 trillion in non-housing debt as calculated in the first quarter of 2019 by the Federal Reserve Bank of New York. According to the Federal Reserve, of all household debts, $ 623 billion are overdue or overdue.
Consolidation with a personal loan is one way to deal with your debt. Known as a debt consolidation loan, it can simplify your payments by consolidating multiple accounts into one, lowering your interest expense and helping you get out of debt faster.
But there are misconceptions about using a debt consolidation loan, including how much it costs and how long it will take. Here are common myths about debt consolidation loans and tips on how they really work.
Myth 1: Debt Consolidation Reduces Your Debt
What’s real: Paying off your debts, be it credit cards or student loans, with a consolidated loan does not diminish or forgive them; rather, your debts turn into a loan and you make monthly payments against that balance.
The idea of reducing or eliminating debt is often promoted through a form of debt relief called debt relief, which usually involves hiring a debt settlement company to ask your creditors to reduce the amount of your debt.
Debt settlement may sound attractive, but it is expensive, can ruin your credit, and take years to work, so approach it with extreme caution.
Myth 2: you will always save on interest.
What’s real: If you have strong credit, you can get an interest rate on debt consolidation a loan that is lower than the rate on existing debt. But your total interest expense may increase if you extend your maturity.
For example, a $ 20,000 credit card debt at an annual interest rate of 15% and monthly payments of $ 600 would mean your total payments are $ 25,800 and take 3.5 years to pay off.
If you upgrade to a personal loan with a seven-year maturity at 10% per annum, your new monthly payment will be $ 332, but your total payment will increase to $ 27,890.
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The new rate and monthly payments are lower, which can improve your cash flow, but longer term means you will pay more interest.
However, you should also avoid shortening your loan to the point where you can’t afford a new monthly payment, ”says Colin Moynahan, Certified Financial Planner and Founder of Twenty Fifty Capital.
Use debt consolidation loan calculator to see how loan rates and conditions affect your payments.
Myth 3: it hurts your credit history
What’s real: Applying for debt consolidation loans often requires a tough credit fee, but this usually only lowers your rating by a few notches.
What’s more, your credit can improve if consolidation means you can better pay off your debts on time, which is 35% of your FICO score.
“A short-term hit to your credit could pay off if it keeps you from paying off your debt plan,” says Ben Smith, CFP and founder of Cove Financial Planning.
Myth 4: it’s expensive
What’s real: Interest rates on debt consolidation loans vary by lender, but are below average credit card rates, starting at 6% for borrowers with excellent credit history or FICO.
score from 720 to 850.
Many debt consolidation loans do not offer additional fees; rather, interest is your only price. Other loans may have a one-time disbursement fee to cover the processing costs of the loan, or small late or check processing fees. Lenders rarely charge a fee for early repayment of a loan.
The annual interest rate on the loan includes a loan disbursement fee, making it easier to compare costs across multiple lenders.
Myth 5: It takes a long time.
What’s realA: Most lenders have an online loan application process that allows you to submit and upload the required documents through a secure online portal.
The entire process, from application to funding, can take anywhere from a few days to a week.
“Some people think that you have to go back and forth with the lender, send documents, hold meetings and interviews, but this is not the case,” says Smith.
Preparing documents such as payment receipts and bank statements before applying can further speed up the process.
“Any preparation that someone can do in the front-end will not affect speed, but it can speed up the process,” Smith says.
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