When it comes to debt consolidation, you might be interested in combining a number of outstanding debts into a single debt.
Maybe you have student loans with multiple servicers and different credit card balances. Or, you have multiple auto loans and mortgage payments. Either way, a debt consolidation loan would allow you to put everything under one lender with one monthly payment.
Debt consolidation loans, especially if you have large debts or numerous accounts, can have a huge impact on your financial situation. And while they can make your life a bit easier, consolidation loans aren’t the right choice for everyone.
Here are 12 truths you need to know about debt consolidation.
Pros of debt consolidation
1. Fewer monthly payments
Maybe your life has become too complicated thanks to debt balances with different due dates and multiple lenders.
Debt consolidation can simplify your life and finances. Fewer payments mean less likelihood you’ll inadvertently forget one.
2. Lower monthly payments
Often times, consolidating with a new lender can lower your monthly payment. This is because a consolidation loan is a new loan, so you’re starting your repayment “clock” over again.
However, keep an eye on the length of the new repayment term to make sure you’re comfortable with it (more on this below).
3. Lower interest rates
Depending on your creditworthiness, refinancing federal or private student loans with a private lender may lower your interest rates. This can also occur with other forms of high-interest debt refinanced through a new lender.
However, consolidating federal student loans through the federal Direct Loan Consolidation program won’t result in an interest rate decrease. In fact, there’ll be a slight interest rate increase.
Cons of debt consolidation
4. Without decent credit, you won’t qualify
Debt consolidation is generally only the best option if your credit score has improved significantly since you took out the original loans you’re hoping to consolidate. That improvement is what will enable you to qualify for better terms.
5. Repayment term may be lengthened
Your monthly payment may be lower, yes. However, that may be because your repayment term has doubled from 10 years to 20 years or more.
With longer repayment terms you may not be saving any money in the long run. Crunch the numbers carefully and ask yourself what your goals are with a consolidation to make sure you’re getting what you want out of the deal.
6. Your interest rate may not be lower
As mentioned above, the federal Direct Loan Consolidation program won’t lower interest rates. In fact, the program takes the average interest rate of included eligible loans and adds 0.25 percent.
And consolidating private loans or other forms of debt at a lower interest rate may not be possible if your credit isn’t great. That’s assuming you qualify at all.
Find reputable, legitimate consolidation organizations
7. For federal student loans
You should never be charged a fee for consolidating your federal student loans through the Direct Loan Consolidation program.
The application is available electronically or as a hard copy. It can be downloaded online at StudentLoans.gov.
If you’re asked to pay an application fee or the website doesn’t end in .gov, then you’re not dealing with the U.S. Department of Education’s consolidation servicers.
8. For private student loans
If you’re hoping to refinance student loans with a private lender, be on the lookout for red flags.
There are plenty of lenders out there hoping to take advantage of debtors whose only goal is to take responsibility and improve their financial situations.
9. Watch for red flags when consolidating consumer debt
Whether you’re considering a personal loan, a home equity loan, a debt relief or debt management program, watch out for red flags that it’s a scam.
When it comes to debt relief organizations, their state licenses, membership in a national trade association, Better Business Bureau accreditation, and non-profit status are clues you’re headed in the right reputable direction.
10. Keeping like debts together may be best
Yes, you’re trying to simplify your life and reduce the number of payments you need to make. However, keeping debts of the same type together rather than consolidating credit card debt with student loan debt or mortgage debt is probably best.
Federal student loans come with many perks you may not want to give up, and even private student loan interest is tax deductible if you meet the requirements. There are always going to be considerations to keep in mind before you embark upon debt consolidation.
11. Your consolidation loans may have a variable interest rate
Right now the interest rates on variable loans are lower than fixed rate loans, for the most part. However, with the Fed planning to incrementally increase interest rates, that could change.
Read the fine print on any debt consolidation loan carefully before you sign on the dotted line. And be sure you’ll save money even if interest rates rise based on the terms of the loan.
12. Don’t rack up more debt
Particularly if you’re using debt consolidation to pay off consumer debt. It can be tempting to use your newly paid-off credit cards to loosen your financial reins.
Remember, runaway credit usage may have been what got you into trouble in the first place. Take whatever actions you need to do to make sure you don’t put yourself in the same situation all over again.
Avoid analysis paralysis
As with every major financial decision, there’s a lot to consider before deciding what’s right for you. However, the above truths are a starting point if you’re contemplating consolidating student loans or other forms of debt.
Only you know your financial picture well enough to determine what your goals are and how best to reach them. The last thing you want is to invest your valuable time into the debt consolidation process only to find that your situation has not improved.
Don’t be intimidated by debt consolidation when it can make your life easier. Ask questions — of yourself and of your (potential) lenders — to make sure you will get what you want and need out of the consolidation process.
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