How To Consolidate Debt, The Smart Way

Sometimes, debt takes on a life of its own.

Even if you're responsible with money, surprises can catch you off guard and, before you know it, one loan turns into an insurmountable pile of debt.

It’s easy to get in over your head.

If you're paying what you can, but your loan or credit card balances are barely moving, it can feel like you’ll be in debt forever! This is just one of the reasons people find it so difficult to get out of debt.

open road with trees on the side overlay that says the smart way to conslidate debt

Should I Consolidate Debt?

Debt consolidation may be a good option for you if:

  • You have the income and credit to qualify for a new loan, and
  • You can meaningfully reduce the interest rate on your debt by consolidating.

Consolidating debt can relieve some of the pressure on your budget, or simply reduce the number of creditors you need to pay each month. In many cases, consolidating your outstanding debt into a single loan can lower your monthly payments, save you money on interest, or both.

However, not all consolidation loans are created equally. There are many alternatives, each with their own pros and cons. The option that's right for you will depend on:

  • What kind of debt you have
  • The total amount of your debt
  • Your creditworthiness and income

Read on to get all the information you need to decide which type of debt consolidation is best for you. We'll also cover exactly how to get started and offer some tips for avoiding the most common debt consolidation mistakes.

What is Debt Consolidation?

Debt consolidation is simply the process of taking out a single loan or credit card and using the proceeds to pay off multiple loans or credit card balances.

The two types of debt that are most commonly consolidated are credit card debt and student loan debt. But, you can also use debt consolidation for payday loans, personal loans, or medical bills.

It’s important to note that debt consolidation doesn’t reduce the amount of debt you owe. In fact, if you pay transfer fees or loan origination fees, you may end up owing more than you did when you started. However, in most cases, the benefits of consolidation make the upfront costs worthwhile in the long run.

Benefits of Debt Consolidation

You may wonder why you should bother with the hassle of consolidating your debt, especially when you’ll likely end up paying extra fees? There are actually several very compelling reasons. Let’s look at an example.

Imagine that you had five credit cards totaling $20,000 in outstanding debt. For this example, we’ll assume the interest rates averag 18.5% and the minimum monthly payments for all five cards totaled $500. In this case, it would take you five years to pay off your debt.

Now, imagine that you’re able to take out a $20,000 loan with a 5-year repayment schedule and a 10% interest rate. Your new minimum payment would be approximately $425 for the same debt and same repayment period.

The new, lower payment gives you two options to solve your debt problems:

The first is to use the monthly savings of $75 to give yourself a little bit of financial breathing room.

This might be the best option if you didn’t have enough cash flow to keep up with your previous $500 monthly payment.

The second option is to continue paying $500 per month so that you can pay off your loan even sooner.

How would these choices impact you?

In the first scenario, you would have an extra $75 per month to support current lifestyle so that you hopefully don't accumulate additional debt, while still saving $900 per year in interest payments. Over the five-year period, you’ll save $4,503. This is a huge benefit, but what if you went one step further and used the extra money to increase your loan payment? This would put you back at your original $500 per month payment while shaving an additional 0.9 years off your repayment schedule. This would allow you to pay the loan off in just 4.1 years and save $1,067 over the life of the loan.

These numbers will obviously vary for each person's individual scenario, but you can see what a huge difference consolidation can make. If you want to see what your consolidation numbers would look like, check out our debt consolidation calculator.

Another advantage is you’ll enjoy the freedom and convenience of dealing with one single loan instead of trying to juggle five credit card payments. It makes life easier, and it reduces the very real risk that you'll miss a payment, incur late fees, and tarnish your credit.

Depending on your credit history, debt consolidation may also give your credit score a much-needed boost. Once you’ve consolidated to a single loan and establish a track record of on-time payments, you should see a positive improvement in your credit score over time.

Now that you understand the benefits of consolidation, the next step is figuring out exactly how you’re going to consolidate that debt.

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