When is debt consolidation a bad idea?
A debt consolidation loan can be the wrong move. If any of the following applies to you, consider alternative solutions.
You run the risk of accumulating new debt. If you pay off your credit cards with a loan only to write off the money again, you will only worsen your financial (and emotional) situation. If you might be tempted to continue using your cards, think twice before using a loan to pay them off.
A safer strategy is to close all credit card accounts when you repay them with loan funds. Then, commit to using only your debit card or cash until your loan is paid off.
If you are worried that closing all your credit cards will negatively affect your credit score, you are right. One of the factors in calculating your score is the amount of credit you have. And if you cover all the cards, it will drop to zero. But paying off your debt is more important (and life-changing) than preventing a temporary drop in your credit rating.
Your credit is bad. If you are struggling to keep your debt, your credit rating may already be below star. Many low interest personal loans require good or excellent credit. Although you may find personal loans on bad credit history, also.
A consolidation loan may not be a good strategy if you cannot significantly reduce the cost of your existing debt. To find out your rate, search the Internet for lenders who soft rather than hard credit check to give you an idea of what you are applying for. Submit a formal application for a serious loan request only if you are confident that you need this loan because serious requests affect your credit rating.
Consolidation will add value to your debt… As tempting as a low payment may seem, avoid a consolidation loan that will tighten your debt by that amount. long maturity that over time you will pay more. As we saw in the example above, you will pay more interest if you extend the loan term.
Benefits of Debt Consolidation
We now know that debt consolidation can lower the interest you pay, make your monthly bills easier, and help you pay off your debts faster. But that’s not all. Here are some more benefits of debt consolidation:
- There is a light at the end of the tunnel because from the day you sign the loan agreement, you know exactly when the entire debt will be paid off.
- The risk of late payments is less because you have reduced the number of invoices you need to track. If you want to reduce it even further, have the monthly payment automatically deduct from your Bank account…
- Paying off your credit card debt can improve your loan utilization rate (provided that you do not take on any new debts). This, along with regular loan payments, should help improve your credit score.
Disadvantages of Debt Consolidation
The danger in life is that something can always go wrong. Here are some things that can negate the potential benefits of debt consolidation:
- You suddenly feel energized because you’ve gotten rid of high interest debt and keep spending money.
- You have debt amnesia and forget how awful it is to feel burdened with revolving debt. As a result, you start using your credit cards again and end up in worse shape than before.
- You are bundled using a transfer card with 0% balance, but you do not refund during the promotion period and end up paying a high annual interest rate. Or you make late payments or otherwise violate the terms of your credit card agreement and end up paying a high annual rate.
- You take out a secured loan to keep your interest rate low, and you risk losing this collateral if you miss payments.
Debt Consolidation Alternatives
If you are not eligible for the loan you want, or decide not to take out a loan for consolidation for another reason, it might make sense to check if you can pay the debt off or manage it differently. Here are a few more ideas to consider.
Debt snowball or avalanche
Debt avalanche or snowball are both ways to pay off debt. You make the minimum payments on all your debts each month, while paying as much as possible against one specific debt. In an avalanche, you focus on the debt with the highest interest rate. In a snowball, you focus on the debt with the least balance.
To make the most of your progress, you must be creative in finding ways to cut your costs and increase your income.
Debt management plan
A Debt Management Plan (DMP) is a formal three to five year payment plan administered by a third party, usually a non-profit credit advisory agency. The administrator will help you restructure the debt (lower the interest rate and cancel the commission). You will be responsible for the monthly payment to the administrator, who then distributes the money to each lender according to a pre-approved plan.
All credit cards included in the DMP will be closed. Your lenders may keep track of your credit report while you are participating in the program, and you may have to agree not to use any loan products during the repayment period.
If you can prove that you do not have enough income to pay off your debts, you may be eligible to pay them off in Chapter 7. bankruptcy… Although the court may sell some of your assets to pay your creditors, many Chapter 7 filers may keep most or all of their personal property.
Chapter 13 bankruptcy is like a debt management plan. You will be making a one-time monthly payment for three to five years. The main difference is that you may not have to pay back your debts in full. The court will approve a monthly payment equal to your disposable income, and at the end of the program, any remaining debt will be canceled. In Chapter 13 bankruptcy, you don’t need to sell your assets.
Like many bankruptcy petitioners, if you are late or do not meet your debts, you have already ruined your credit. Bankruptcy may not affect your account much. The lower your score, the less it will drop as a result of filing for bankruptcy. However, bankruptcy information will remain on your credit report for up to ten years.
The cost of filing a bankruptcy petition ranges from a few hundred dollars if you represent yourself to several thousand dollars that will be presented by a lawyer.
Amortization works by negotiating with your lenders for a lower interest rate, lower balance sheet and / or lower fees. You can do it yourself, one account at a time, or you can use a debt settlement company to negotiate multiple debts on your behalf for a fee. If you use the services of a debt settlement company, you will send them one payment every month. The company then makes the agreed payments to each of your creditors.
Debt settlement may look like a debt management program, but there are important differences. First, you will pay a commission to the debt settlement company. In addition, your debts will be considered settled and not fully paid. This can make it difficult for you to get a new loan on favorable terms for the first few years after your debt has been settled.
Another potential drawback is that debt settlement companies usually collect your monthly payments over a period of time before negotiating with your creditors. This is because lenders are less interested in negotiating if your account is valid. They could have made a deal more readily if they thought they would not receive their money. Meanwhile, anyone who reads your credit report will think that you made no effort to meet your obligations, even if you diligently made payments. And all the while, you are deteriorating your reputation. Delayed payments remain on your credit report for seven years after the date of the delay.
What do you need to apply for debt consolidation?
If you are looking to apply for a debt consolidation loan, it is helpful to have everything you need in front of you, including:
- Employment history… Lenders want to know that you are not looking for a job and that you have a regular job. Be prepared to provide your employer’s contact information. They may also ask why you left your last employer.
- Proof of income… Your income will be checked to make sure you have enough earnings to pay all monthly bills. Verification may require access to payment stubs, bank statements, or your previous year’s tax return.
- ID confirmation… Lenders will require proof of identity to make sure you are who you say you are. The identity document may include your driver’s license and another element, such as a voter registration card or passport.
- Debt to Consolidate… Lenders also need a comprehensive list of every debt you wish to consolidate, including the names and addresses of the creditors and the outstanding balances.
Is debt consolidation right for me?
Very few Americans are immune to money problems. If you’re having trouble managing your debt, consolidation can be an easy and cost-effective way to ease your debt. But only if the benefits are clear.
A debt consolidation loan can be part of a well-planned financial recovery. You may be able to make debt repayments more manageable and save on interest. The goal should be to pay off debt as soon as possible at the lowest possible cost.