Last Updated on 3 years by INDIAN AWAAZ
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You keep hearing consolidation mentioned as a potential solution to your debt woes. The common strategy “consolidates” your unsecured balances – typically credit cards – into one fixed monthly payment, ideally with a lower interest rate. This makes bill paying easier since you no longer have multiple bills of varying amounts and rates. But there are some nuances that need breaking down. Here’s debt consolidation simplified.
Perhaps you have multiple credit card balances and personal loans with different rates and terms. Instead of trying to erase these debts individually – which can take forever due to high interest rates — you can get a consolidation loan to pay them off in one fell swoop. This leaves you with only the loan to repay.
You just need to make sure the loan carries a lower interest rate than what you’re paying in total on all your current debt.
Methods of Consolidation
There are several forms of debt consolidation. The approach that’s right for you depends on various factors, including your credit score and type of debt.
- Balance transfer. With this approach, you can shift your high-interest credit card accounts onto a 0%-interest credit card that issuers offer for an introductory or promotional period. You’ll need good credit to qualify, though, and you also must be able to pay off those balances before the promotional rate ends and the regular rate kicks in.
- Debt consolidation loans. These are usually unsecured personal loans that are meant for paying off debts. Such loans typically have a fixed interest rate and repayment schedule.
- Debt consolidation programs. Also called debt management plans, such programs group multiple credit card debts into a single payment, slash your interest rate, and establish a three- to five-year repayment plan. Arranged through a credit counseling agency, such programs typically cover unsecured debt, which are loans not secured by collateral.
- Student loan consolidation. Such loans, which are available for private and federal loans, allow you to consolidate your balances into one loan with a single monthly payment. This route is especially useful if you have multiple student loans with different servicers.
- Home equity loans and lines of credit. With home equity loans, you can borrow up to around 85% of your home’s equity and make repayments over a fixed term. A home equity line of credit works like a credit card in that you can pull money when you need it and only fork over interest on the cash you borrow. You’ll subsequently use the funds from the loan or line of credit to clear your existing debts. Be careful, however: you risk losing your home if you default on payments.
- Cash-out mortgage refinance. Here, you obtain a new mortgage that exceeds the balance of your first one. You use the new mortgage to clear the old one, leaving you with cash you can use to cover existing debts. Be mindful of closing costs that usually accompany cash-out refinances.
How Much is it to Consolidate Debt?
Depending on the kind of consolidation you choose, you will likely incur additional fees. Balance transfer fees, for example, usually range between 3% and 5%. Personal loans used for debt consolidation carry “origination” (processing) fees, and there are closing costs for mortgage-related loans and lines of credit.
Now that you’ve had debt consolidation simplified, you can confidently choose the method that fits your financial situation. The most important thing here is to get started today. Soon you’ll set foot on a better financial path.