What Are the Advantages of Debt Consolidation Loans?

It can seem like you’re not making any progress with your debt, even if your bills are paid each month. Consolidating debt is an excellent option.

Consolidating debt is when multiple debts are combined into one loan with one payment per month and one (hopefully lower) interest rate. This will save you time and help keep your finances in order.

What is a consolidation loan to repay the debt?

A debt consolidation loan is one way to consolidate debt. Once you are approved, the loan funds will be available to repay your debts. The loan will then be paid back over time.

When choosing a consolidation loan to consolidate debt, you will need to consider a variety of factors.

Type of loan: The most popular loans are personal loans, credit cards with an introductory 0 percent APR, 401(k), loans, and home equity loans.

Lender terms: The terms of your loan are determined by the type of loan you take and your financial situation.

Secured loans vs. unsecured:<span style=”font-weight: 400;”> A secured loan will require collateral. Your home is the collateral for a home equity loan. If you fail to make payments, the lender could take your collateral. Your assets are not at risk by remaining with your unsecured options, such as personal loans or a 0 percent APR credit card.

What is a consolidation loan for debt?

Fixed-rate installment loans are often used for debt consolidation. Fixed-rate installment loans for debt consolidation have an interest rate that is fixed and only one monthly payment. Consolidating multiple credit cards with different interest rates and minimum monthly fees can be done using a consolidation loan. You will only have one monthly payment instead of three.

Let’s say you have credit card debt. These are some of the ways that a consolidation loan could help reduce interest costs.

  • Card 1 has a balance of $5,000 and an APR of 20%.
  • Card 2 has a balance of $2,000 and an APR of 25%.
  • Card 3 has a balance of $1,000 and an APR of 16%.

If you pay off your credit card balances within 12 months, your interest costs will be $927. Let’s say you borrow $8,000 to pay off the amount owing. The APR is 10%. If you pay it off in one year, the interest cost will be $440. A personal loan calculator and a credit card payment calculation can help you calculate your savings.

Consolidation loan benefits

If you want to reduce costs, make your payments more manageable, and set a date for your repayment, debt consolidation may be the right choice. These are the top benefits of debt consolidation.

  • Reduce your debt faster. By making minimum payments on your credit card, you can extend your repayment period. A consolidation loan may help you pay off your debt quicker.
  • Interest costs can be reduced. If your interest rate is lower than the current rate, you will be able to save money. As of October 2020, the average credit card interest rate was 16.02%, and the average personal loan rate was 11.88%.
  • Reduce the complexity of your monthly payment. It’s easier to manage one monthly cost rather than multiple charges with different due dates. This will lower your chances of missing payments, which is great for credit.
  • You will be required to pay on a specific schedule. You can consolidate your debt with fixed installment loans. This will let you know when your debt has been paid. This can be an excellent way for you to stay motivated while working on your debt.

Consolidation loan risks

You must balance your immediate and long-term needs before you can move forward. Consolidating your debt can help you to save money and manage your monthly payment. There are downsides.

  • It won’t solve all your financial problems. After you’ve used the debt consolidation loan, it is possible to feel tempted again to use your credit cards. This could increase your debt and make it harder to pay your balances.
  • There may be initial costs. You might have to pay fees for debt consolidation loans such as origination fees, balance transfer fees, and prepayment penalties. Before you apply for a loan, talk to the lender.
  • You might be able to pay more interest in some instances. This could occur in one of two ways. Your credit score and debt to income ratio could impact your interest rate. Consolidating your debts and lowering your monthly payment might result in you paying higher interest.

Understanding debt consolidation loan interest rates

Repaying a consolidation loan will result in interest payments each month. Interest rates on debt consolidation loans are typically between 5.99 percent to 35.99%. Higher interest rates can lead to higher monthly payments. Because every lender sets rates differently, you can shop around for the best rate.

Lenders generally consider these factors when deciding if you are eligible for a loan and setting your interest rate.

  • Credit score: To be eligible for a consolidation loan, borrowers must have a credit score of at minimum 600. Higher credit scores could lead to lower interest rates.
  • The DTI ratio (debt to income) shows lenders how much of your monthly income goes toward debt payments. A lower DTI is more acceptable by lenders.
  • Income: The lender will verify your income and confirm that you can pay the loan.

Even if your credit score isn’t perfect, you may still be able to find a lender who will lend you money. Your interest rate could be higher. If you find yourself in this situation, consider adding a cosigner. If you default on your loan, the cosigner will pay it back. Before agreeing to the loan, they should be fully informed.

How to apply for consolidation loans?

Consolidating loans can save you money, even though there are some steps involved. Start by pulling your credit reports, comparing quotes from different lenders, and assessing your likelihood of loan approval.

  • Be aware of your financial situation. A strong credit score will improve your chances of getting a consolidation loan or a great rate. Check your credit score before applying to consolidate loans or get a great interest rate.
  • Compare lender terms. Consolidating debt can be cheaper if you shop around. To compare quotes, compare the monthly payments, interest rates, and fees from multiple lenders.
  • Prequalify. Some lenders offer prequalification. This will give you an idea of the type of offers that you may receive. Many lenders can prequalify you, but it won’t affect your credit score.
  • Before applying, make sure you have everything you need. For a consolidation loan application, you will need to have your Social Security number, contact information, and an estimate of your monthly debt obligations. You also need pay stubs, information about your employer, and proof of income.

Once approved, your lender will either send the funds directly to you or pay your creditors. Once you have settled your original debt, you can start your new loan. You have the option to set up automatic payments or remind yourself to pay your monthly dues. You will eventually become debt-free.