Debt consolidation could be a good way for you to burrow out from your obligations. To know for sure, you need to understand the process and how it could work for you.
First off, debt consolidation combines multiple debts from credit cards, high-interest loans, and other debts into a single monthly payment. The process should provide an interest rate that is lower than the aggregate rate you’re paying on existing debt. This can help you save money on interest and pay down debt quicker.
Credit Scores Matter
A strong credit score will enable you to qualify for the lower interest rates that make debt consolidation sensible. If your credit is lackluster and the only loans for which you’re eligible are high-interest personal ones, then you won’t save sufficient cash to make the strategy worthwhile.
Laying The Groundwork
Before you apply for a credit consolidation loan, it’s also smart to develop a plan to pay off your obligations and alter your spending habits to be certain you can make the monthly payments. If you have too much debt, the monthly payment you’d have to make might be unaffordable. Put together a household budget indicating how much you earn monthly and what you spend. After you calculate how much you can afford, you can determine whether the plan will work for you.
Kinds Of Debt Consolidation
One is a balance transfer, which switches high-interest debt from credit cards, loans, retails cards, and other unsecured debt to a credit card with a low promotional annual percentage rate (APR). Making monthly payments on a low-rate debt can help erase the balance sooner.
For example, if you have a credit card with a $3,000 balance and an 18 percent APR you would incur $300 in interest charges if you cleared that debt with 12 monthly payments of $275.
Say you transferred that balance to a card that features zero percent introductory APR for a year on balance transfers. That card company would likely charge a fee of roughly three percent of the balance. If you made the same monthly payment of $275 on your new starting balance of $3,090 for 11 months with one last $65 payment in the final month, you would save $210 in interest charges.
Another form of debt consolidation is a debt consolidation loan, wherein your current obligations will be folded into a personal loan with a fixed monthly payment. This strategy only makes sense if the interest rate on your loan is less than the average rate on existing balances.
Yet another form of consolidation is a home loan. If you own a home, you can use the equity – the difference between what you owe on your mortgage and the home’s current value – in the structure to consolidate your debt. You would repay the loan with monthly outlays, usually at a fixed rate. In the meantime, you could use the home loan to pay off your other, more expensive debt.
The risk, of course, is that if you fall behind in your loan payments, you’re at risk of losing your home.
If your employer allows you to borrow against your 401(k) plan, you could pay off debts that way too. The downside is that if you fail to repay your loan in time, you’ll have to pay taxes on it. That’s in addition to a 10 percent early withdrawal penalty if the withdrawal is made before you’re age 59-and-a-half.
You should also remember that your 401(k) is supposed to be for your retirement. When you withdraw monies from that fund, it subtracts from the amount of cash you’ll have for that season in your life. You must decide whether erasing your high-interest debt is worth the reduction.