What are the Pros and Cons of Debt Consolidation

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Debt is an issue that plagues millions of people worldwide. In the United States in particular, people often tend to live and spend on credit more than in many other countries. American Consumer Debt reached a staggering number of $14.96 trillion in 2021.

High debt balances cause hundreds of thousands of people to experience debt-related financial stress every year. Unable to repay multiple debts at once, consumers are faced with higher higher interest rates and predatory lending practices. In certain cases, consumers can't manage the unrelenting financial pressure. Missed payments and defaulting loans have far-reaching negative consequences that are dangerous for one's financial situation.

There are a couple of ways with which you can start improving your credit score and managing debt effectively. Some of them include working with creditors in an effort to settle outstanding debts, applying for home equity loans, or getting a debt consolidation loan.

Debt consolidation loans can help you turn multiple payments into just one monthly payment, usually with a lower interest rate. This might sound like the perfect way to deal with debt, but before making that choice, you'll have to consider the pros and cons of debt consolidation.

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What does debt consolidation mean?

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Debt consolidation pertains to the process of combining multiple debts into a singular one. This process is usually undertaken by consumers who cannot deal with the high-interest rates of their debts or have multiple creditors that become difficult to manage.

Often, a debtor will agree to buy-down and consolidate your other debts to take advantage of the higher outstanding balances and increase the likelihood of repayment.

Debt problems are common and can usually cause plenty of financial problems, especially if you've missed payments. Debt consolidation is a step that you can take to simplify the problem and focus on only one issue instead of multiple.

You can consolidate credit card debt, student loans, car loans, and debt due to medical bills into a new consolidated loan with a preferrable interest rate and a fixed monthly payment amount. Ultimately, it might lead you to improve your credit history and help you save more money.

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Is it a good idea to consolidate debt?

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There are specific scenarios where debt consolidation is a viable and recommended course of action. In order to determine whether or not you need to do it, take a look at these qualification metrics:

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• Positive credit scores and credit report - There's a specific baseline for determining whether or not choosing a debt consolidation loan is worth it. If your credit score is at least 670, then you'll often end up with a lower monthly payment if you choose to consolidate.
  
• You prefer making a single monthly payment - Having to make multiple monthly payments can be confusing and stressful. A debt consolidation loan will fix this problem by turning all your loans into one singular monthly payment.
  
• You prefer a fixed interest rate and fixed payments - While other types of loans may not have fixed amounts for each month, debt consolidation loans often do. They can also have a very attractive repayment term so if that's what you're looking for - a debt consolidation loan is the perfect choice for you. Variable interest rates can be dangerous because sometimes you miss the fine print on what triggers higher rates and you end up paying more interest than principal. Lots of high-rate, variable loans are usually bad for consumers.
  
• You have money to complete the repayment period and repay the full loan amount - Although debt consolidation loans seem perfect, they still carry a certain dose of risk with them. For starters, if you miss payments, you'll still incur interest penalties and may end up in even bigger financial trouble. Make sure you can afford to pay off the entire loan. Pro-tip: Make sure you get a consolidated loan that allows you to prepay your outstanding balance earlier if possible. While you may only be able to afford your regular scheduled payments, it's a good idea to pay down your debt balances if you do come into some more money. This will get you out of debt faster.

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How to get a debt consolidation loan

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If you've decided that a debt consolidation loan is for you, then it's time to go through the process of applying for and creating one.

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• Explore your own credit reports and scores - Most banks and lenders require a minimum credit score before accepting your loan request. It would be best if you take a look at your credit report for any irregularities and your credit score to see if you're eligible. Keep in mind that online lenders function the same way.
  
• Compare different lenders - Not all lenders are the same; some offer loans with origination fees while others don't. But those that don't may provide you with high-interest credit cards. The truth is, you should 'shop around' and compare a couple of lenders to get the best deal out of all of them.
  
• Settle on the loan amount you want - Speaking of the origination fee, before you apply for debt consolidation, take a look at how much you owe already, within the other personal loans. This is done to determine how much you'll need to borrow but also take into account the aforementioned origination fees and other loan terms.
  
• Get pre-qualification - Most lenders will do a quick, soft credit check for pre-qualification meaning your credit score won't be affected. In any case, pre-qualification is done by the lender and it involves a process where they give you an estimate of what your loan term and rate may be.
  
• Apply for the debt consolidation loan - Once all the previous steps have been completed, you can go ahead and apply for the debt consolidation loan. This can be done online, in person, or by phone, and you'll be required to provide personal information to the lender such as your full name, income levels, and date of birth.
  
• Receive your funds in one payment - You can repay all your debts with this loan and you'll usually receive the money in a day or two. If the consolidation loan pays your other debtors off automatically, even better! Remember that, although this is a lower interest loan, your new monthly payment will still need to be done on a regular basis. You don't want to pay interest by missing payments. Additional financial options down the road may be limited.

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The pros of debt consolidation

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There are a couple of debt consolidation pros that are worth considering before making the choice.

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Simplification of finances and improved financial protection

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A single personal loan is fine, two are manageable, but too many more can turn catastrophic fast. These consolidation loans exist to help you focus on just one aspect of repaying borrowed money.

This also gives you slightly better financial protection since your main goal is paying back the debt consolidation loan instead of multiple instances of credit card debt and other debt types. You'll be more equipped to deal with finances and you'll more easily divide your money to where it should be used.

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Repay debt faster

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If you have some significant credit card debt, then the pros of debt consolidation come into full effect here. For starters, credit cards don't require a fixed payment period for paying off indebted credit card balances.

On the other hand, debt consolidation loans do; you'll be paying the loan back each month for a fixed period of time - from beginning to end. This essentially means you'll accrue less interest on that loan for its entire duration. And the sooner you pay off that debt, the sooner you'll be able to fill that emergency or retirement fund.

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Fixed payment schedule

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Using a personal loan to repay your debt is useful because you'll know exactly when your final payment will be. A debt consolidation loan works the same way. Having a fixed schedule keeps your interest rate the same throughout the duration of the loan so you'll end up saving some money.

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Lower interest rate

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The average interest rate for credit cards has been 16% or more in recent times. This is 5% higher than the average personal loans rate of 11%. There will of course be differences and certain stray percentages, depending on which lender you go for but overall - a lower credit rate means a better credit rating if you pay it all off on time.

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Boosts credit scores

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A word of advice here - don't freak out if you see your credit score go down once you take out consolidating debt. After all, your credit history will be analyzed by the lender in a hard-credit inquiry.

However, as time passes, your credit utilization ratio and the overall health of your payment history will only go up. The reason for this is making easier on-time payments considering you'll only have one loan to repay. Credit history is the main factor in determining your credit score. When consolidating your debt, take a long-term approach.

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The cons of debt consolidation

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Not everything is as positive as people think so here are the cons of debt consolidation.

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Doesn't really make you debt-free

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Although you're technically receiving money to pay off your existing debts, you'll still end up owing money to the lender. Combine this with the fact that some people severely overspend their budgets and you've got a recipe for disaster.

The only way these loans end up being successful and useful for people is if they know how to use them. So make sure to create a realistic budget so consolidating debt doesn't end up causing even more debt.

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Additional up-front, closing costs and annual fees

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Certain lenders only offer debt consolidation loans if you pay some additional fees. These fees can include:

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• Closing fees
• Loan origination fees
• Various yearly fees
• Balance transfer credit card fees

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It would be wise to ask around and see what kinds of fees you'll have to pay and how large they are. Ideally, you would want a lender without any of these fees or with, at most, one or two (provided they aren't too large).

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Missing the one monthly payment will cause even more issues

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Do your best to not miss any monthly payments as that can severely impact your credit score, especially when consolidation loans are involved. For starters, missing a single payment would mean you'd have to pay a 'late payment' fee along with a 'returned payment' fee due to insufficient funds.

Additionally, lenders usually report late payments to the credit bureau some 30 days after it's due which will damage your credit score even more. And just like that, your financial future may become unstable. Always make payments on time!

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Final Words

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The pros and cons of debt consolidation are plentiful but it's up to you to decide whether or not you need said loans. It all depends on what you're looking for and if you can pay off the consolidated loan compared to the multiple you may already have.

You can save some money this way, but you can also lose more than with multiple auto loans or student loans. In any case, if you need specific help, hiring a financial advisor or licensed creditor is a good idea. Good luck!

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