Debt consolidation is the practice of taking multiple forms of debt, usually high-interest products, and combining them into a single monthly payment. It is seen as a particularly advantageous form of debt management for two reasons:
- By consolidating your debt, you may get a lower monthly interest rate relative to the total interest rate of your individual debt products.
- It organizes your debt so that it is all in one place, rather than scattered amongst several debt products.
Whether you struggle with personal financial management and need extra clarity, or simply want to reorganize your range of bills into one payment with the same due date and interest rate, debt consolidation can be a good option for many people.
Where Do I Start with Debt Consolidation?
There are two main methods of debt consolidation – both of which are about consolidating debt into one place.
- Get a 0% interest balance credit card and transfer your debt. After you register for the card you can move all of your debt onto this card. At the end of the promotional period, you’ll need to pay off the balance. To qualify for one of these credit cards you’ll typically need an excellent or good credit score (690 or above).
- Find a fixed-rate debt consolidation loan. When you sign up for this type of loan, you will receive a bulk payment and use it to pay off the full balance for each of your debts. This means that you’ll only have one loan remaining . If you have bad or very bad credit (689 and below), you are still able to qualify for this type of loan. However, if you have good credit, you’ll typically get the best rates.
There are two further ways to consolidate your debt: a Home Equity Loan or a 401(k) loan. However, these are the two most risky types of debt because they could impact your home or retirement.
When Is Debt Consolidation A Good Option?
If you want to go down the debt consolidation route, there are some things that must be in place before you do so:
- Your monthly debt repayments including what you pay on rent or mortgage exceed 50% of your gross income.
- You have a credit score that is high enough to qualify for a debt consolidation loan or balance transfer credit card.
- You make enough money each month to cover your debt repayments consistently.
- You need to be able to pay off the loan within 5 years.
A good example of when debt consolidation makes sense:
You have five credit cards and the interest rate ranges from 17.5% to 26.99%. Your credit is ok because you always pay your bills on time. You are therefore able to qualify for unsecured debt consolidation at around 7.5%, a much lower rate than what you’re paying on your credit card interest.
Taking out a debt consolidation loan can be a light at the end of the tunnel for those swamped by many different debt repayments. If you decide on a four-year debt consolidation product, then you know the debt will be gone after the term ends (as long as you make on-time monthly payments and you don’t build up more debt.)
When Is Debt Consolidation Not The Right Option?
Consolidating debt is not the right option for everyone. It only addresses the current debt that you have, not the spending habits that have led to the necessity of debt consolidation. Addressing this issue would be potentially more advantageous than choosing debt consolidation.
It further may not be the right option if your debt load is small and manageable. If you can repay your current debt in half a year to a year at your current repayment schedule, then debt consolidation would probably only save you a negligible amount.
Finally, if the total amount of your debt is over 50% of your income even after debt consolidation, then you should look to get debt relief instead.