Generally, debt consolidation involves taking out a new loan with lower interest, to pay off existing debts. Debt consolidation can be a great way to reduce your monthly payments and streamline loans, if you struggle to remember individual payment dates, or if you’ve improved your credit score.
Debt consolidation can be used to pay off any individual debts like auto loans, student debt, personal loans, and credit card balances.
How Does the Debt Consolidation Process Work?
When consolidating debt, a borrower applies for a balance transfer credit card, a personal loan, or any other consolidation tool via a lender or bank. In a debt consolidation loan, the borrower can take cash and pay off his or her outstanding dues, or the lender may directly pay off the debts of the borrower.
Once these pre-existing debts are cleared with the new loan money, the borrower is required to make a payment towards the new loan every month. The amount paid by the borrower towards the debt consolidation loan is comparatively lower.
Is It a Good Idea to Choose Debt Consolidation?
Typically, the steps you take to improve your financial habits and your credit score will help you decide if debt consolidation is actually a good idea.
Under the following circumstances, debt consolidation might be a good idea if:
– You have sufficient cash flow to cover all your debt payments
– You’re prepared to make early payments, or you don’t mind paying off the loans over a long period of time
– You want to pay off the entire debt amount under a consolidated loan
– There has been an improvement in your credit score since you took your original loan (this could make you qualify for a better interest rate)
– You have a plan in place that won’t get you into the cycle of debts again
However, debt consolidation may be a bad idea if:
– You don’t have a plan to avoid new debts
– You can’t cover the new monthly payments on your debt consolidation loan
– You don’t want to take any additional steps to pay off your debts
– Your outstanding debt can be paid off soon, so consolidation won’t help you save significantly