Between student loans, auto loans, and credit cards, it becomes tough to stay on top of payments on outstanding debts. Debt consolidation may be the answer. Simply put, debt consolidation entails merging two or more loans into a single debt.
Combining all these debts into a single loan may simplify your finances, but it is unlikely to solve underlying financial issues for every borrower. Thus, it is critical to come to terms with the benefits and drawbacks of debt consolidation before taking out a new loan.
Here are some pros of debt consolidation:
- Setting A Deadline To Repay The Debt
One of the biggest upsides of debt consolidation is its set term. Broadly put, the loan's end date is clearly defined, so you have a deadline to work toward when it comes to paying off your debt. Knowing how much you have to pay at a specific time makes it easier to manage your finances and ensure better future planning.
To make your life easier, modern-day lenders provide a range of debt consolidation loans. You can easily pick the one that goes best with you. Do not assume finding a suitable lender is a tough nut to crack. You just have to Google “debt consolidation loans” along with the area in which you reside. To give you a better demonstration, if you live in Newzealand, you just have to type something like “best debt consolidation loans in NZ,” and the search engine will flood your screen with a truckload of lenders.
- Improves Credit Score
Credit ratings indicate a borrower’s potential to make timely payments, but they are not the sole determinant of their credit score. Among other factors, credit reporting companies also place a high value on your credit utilization ratio, which might account for up to 30 percent of your credit score.
Keeping your credit utilization ratio low is mandatory if you don't want your credit to be negatively affected. When you consolidate your debts, you may be able to obtain new credit while also paying off your previous debts. That way, you can eventually end up lowering your credit utilization ratio and potentially improve your credit score.
- Lowering Interest Rate
Some of your unsecured debts, including personal loans and credit cards, may have a high-interest rate, which can considerably increase the amount you owe each month. In addition, you can save money in the long term by consolidating many loans into one. To guarantee that you get the best deal possible, conduct research and look for lenders who offer a prequalification process.
- Less Stress
Over time, consolidating all your debts into a single payment will help you feel less stressed and clear up the mess that multiple payments can make. It is because instead of having to remember several due dates for debt payments each month, the debt consolidation will ensure you will only have to remember only one date.
The entire payment can also be automated, thus removing the hassle from the equation. Having more time on your hands will allow you to focus on other aspects of your financial health, such as budgeting and investing.
Now let’s explore a few downsides of Debt Consolidation:
- Compromise On Flexibility
Indeed, you will have only one payment to deal with after getting a debt consolidation loan. With that said, the amount of that single payment will likely be higher than any single payment you have had before. So when your budget gets a little tight, you will not have enough flexibility to cope with the situation.
- Additional Costs
People who get debt consolidation loans may be liable to pay money upfront. Loan origination, annual, and closing costs are the most common additional expenses. These extra fees could hurt the amount of money you may save by consolidating your debts.
- Limiting Future Options
You face the chance of losing out on certain opportunities if you tab into debt consolidation. For example, consolidating federal student loans into private loans may result in missing out on available repayment plans. Apart from that, if you try to liquidate your debts by converting unsecured debt to secured debt, it may be difficult to file for bankruptcy.
Furthermore, because lenders often disclose late payments to credit bureaus when they are 30 days past due, your credit score may be severely harmed. As a result, it may be more difficult for you to qualify for future loans and obtain the best interest rate.
- Temptation Of Overspending
There is no denying that debt consolidation leads to a sense of relief for someone who is overwhelmed by debt. But it can also backfire big time. The reason being when consolidating debt, you may be eligible for more credit than you owe, which may tempt you to spend. If you utilize a personal loan to pay off a credit card, it may be enticing to use the credit card for fresh purchases.
- Requires Serious Commitment
Contrary to the common assumption, consolidating debt is not a quick fix. Whatever strategy you select, you must be dedicated to seeing things through to completion and paying off your debts. If you use debt consolidation as a short-term solution to make things easier, it may work for a while, but you will soon find yourself in a worse situation than before.
A debt consolidation loan may be the first thing that comes to mind when considering how to handle your debt efficiently. In most situations, debt consolidation loans are used to pay off various debts by merging monthly payments into a single payment with a lower interest rate. At the onset, this may appear to be a perfect option, but we want you to be fully informed about its pros and cons as it will help you decide whether or not this is the best course of action for you.