The Pros and Cons of Debt Consolidation & Methods
As of June 2018, Americans carry over $1 trillion in revolving debt, according to data from the Federal Reserve. And carrying debt can be troublesome if it has high interest rates. Credit cards, for example, had an average rate of 15.54% in the second quarter of 2018. That can make it hard for you to … Continue reading The Pros and Cons of Debt Consolidation & MethodsThe post The Pros and Cons of Debt Consolidation & Methods appeared first on MagnifyMoney.
Posted — UpdatedLike any financial strategy, debt consolidation isn’t perfect. There are pros and cons to consider anytime you restructure your debt or take out a new loan.
In this article we’ll cover:
The pros of debt consolidation
The cons of debt consolidation
Breaking down each debt consolidation method
The bottom line
Pros of debt consolidation
The advantages of debt consolidation are often important enough for consumers to overlook any potential downsides. That’s because debt consolidation has the potential to save you money while getting you out of debt.
Here’s a rundown of how debt consolidation could help you save money, along with the additional advantages that come with this strategy.
1. You could repay your debt sooner
Imagine you have $6,000 in credit card debt at an APR of 15%. If you made a minimum payment of $120 each month, you’d pay a total of $9,473 over seven years. But if you consolidated your debt into a personal loan with an 8% APR and made the same monthly payment, you’d repay a total of $7,323 over five years instead. That’s a savings of more than $2,000 and two years of loan payments.
Pritchard notes that high interest rates make it difficult to pay down debt, whereas a lower rate can help you make a bigger dent in your balance with each monthly payment you make. If you’re able to consolidate to a lower rate and keep making the same monthly payment, you can make a lot of progress in a shorter amount of time.
2. You could simplify your finances
By consolidating your debt into a single new loan, you can go from multiple monthly debt payments down to one. This could make it easier to stay on top of your payments and focus on your end goal, Frankle said.
3. You may be able to secure a fixed repayment schedule
If you consolidate debt with a personal loan, you could opt for a fixed interest rate. That would make your monthly payment and repayment period easier to manage. Plus, you couldn’t tack on more debt to your personal loan. Just be wary of accumulating new debt on your paid-off credit card.
Cons of debt consolidation
While securing a lower interest rate can help you save money on your debt, consolidating with a personal loan or another financial product does come with risks.
Some of the main disadvantages of consolidating your debts include:
1. Consolidating your debt won’t solve your financial problems on its own
“For people who have bad spending habits, I would recommend seeking help from a budget coach or financial planner first,” he said. That way, you can get to the root of your problem and prevent a situation where you consolidate debt but continue racking up new debt.
2. Debt consolidation can cost money on its own
Depending on how you choose to consolidate your debt, you may have to pay upfront costs. For example, personal loans can come with origination fees from 1 percent to 8 percent. Home equity loans, on the other hand, come with closing costs similar to those of a traditional mortgage.
These costs or fees can offset your savings, Pritchard said. For that reason, you should factor in any fees you’ll pay to ensure debt consolidation is worth it. Also consider looking for debt consolidation options that don’t charge any fees.
Pros & Cons of each debt consolidation method
Before you consolidate debt to save money or speed up your repayment timeline, you may want to consider the different loan options available. Consider this breakdown of the popular debt consolidation methods, along with their pros and cons.
A balance transfer card is a type of credit card that offers 0% APR for a limited time. These cards may let you transfer multiple credit card balances and loans over to the new rate, helping you save money on interest and score a single monthly payment.
Pros
- If you can pay off your debt during your card’s 0% introductory term, this option is basically an interest-free loan.
Cons
- Most balance transfer cards charge a 3% to 5% fee to transfer your balance.
Who is it best for?
Balance transfer cards make the most sense for people with high credit scores because they can usually qualify for the promotional rates. These cards are also best for consumers who can stop using their credit cards so that they can focus on paying off their debt for good.
Where to find the best offer
A debt consolidation loan is a personal loan used to consolidate debt. Personal loans come with a fixed interest rate, monthly payment, and repayment schedule.
Pros
- Personal loans can offer attractive interest rates that can help consumers save money in debt repayment.
Cons
- While debt consolidation loans can lower your monthly payments, you may end up paying more in interest if you stretch out your repayment timeline, Kellermeyer said.
Who is it best for?
Debt consolidation loans are best for consumers who need a structured way to pay off their debt. They’re also a smart option for consumers with high credit scores since they may be able to qualify for the lowest interest rates.
Where to find the best offer
A home equity loan is a fixed-rate debt that uses the equity you have in your home as collateral. You’ll have a fixed monthly payment and repayment timeline.
Pros
- Since this is a secured loan, you may qualify for a lower interest rate than you could get with other debt consolidation options.
Cons
- You can only borrow up to 85 percent of your home’s value with a home equity loan. So this option may not be available to some homebuyers.
Who is it best for?
“A home equity loan might make sense if you have significant equity in your house, a secure income source that’s going to keep you out of foreclosure, and you really want to minimize your interest rate,” Pritchard said.
Where to find the best offer
A home equity line of credit (HELOC) is a line of credit that lets you borrow against the equity in your home. HELOCs typically come with variable interest rates.
Pros
- Since HELOCs are secured by the equity in your home, they can offer attractive interest rates.
Cons
- HELOCs can come with fees, including for applications, title searches and appraisals. But not all HELOCs charge these fees, so make sure to shop around.
Who is it best for?
HELOCs are best for consumers who have a lot of equity in their homes and want a line of credit to borrow against.
Where to find the best offer
Pros
- Gallegos said a debt management plan could “simplify bill-paying by combining debts to obtain one interest rate and one payment.”
Cons
- Debt management plans typically charge a monthly administration fee. These fees can add up over the course of a debt management program. But these fees can be offset by the interest you save.
Who is it best for?
Gallegos said debt management plans are best for consumers with less than $7,500 in unsecured debt who can make monthly payments, and who would benefit from a slightly lower interest rate.
Where to find the best offer
The bottom line
Consolidating debt can be a good move if it helps you save money or repay your debt faster. But it’s important to consider all your options before you pull the trigger.
The right debt consolidation method for you can vary. Consider what kind of debt you have and how much you have of it, your current interest rates and which consolidation methods are available. By doing some research, you can wind up with the best debt consolidation product for your unique needs.
Copyright 2024 Magnify Money. All rights reserved.