How does debt consolidation work?

More and more people are finding themselves struggling with high-interest debts and are urgently seeking a strategy to work their way back to financial stability. While there are a few options available, many of them require drastic measures that can have a lasting impact on one’s credit. For those wanting a solution that does not result in as much disruption, debt consolidation is the way to go. 

Before committing to a repayment process, it is necessary to fully grasp how debt consolidation actually works and if it would be the route to take. 

Understand Your Debt Situation

If you’re having trouble managing multiple payments and hefty interest rates, debt consolidation could be the solution for you. Before diving into the world of debt consolidation, it’s essential to assess your current financial situation and understand how this process works.

Get clear on what you owe:

Before you can find out the best way out of debt, you need to compile the full picture of what your outstanding amount is. Along with the final number owing you will want to determine what the various interest rates are, and what those add up to. This step is exceptionally important as it will highlight exactly the amount of interest (not principal) you are paying each month, which you can use to compare with the interest payments that would be taken for a consolidated loan. 

  • Credit Card Debt: Credit cards often have high-interest rates that can make it difficult to pay off the balance quickly.
  • Personal Loans: Personal loans can be either open or closed and offer better rates that credit cards.
  • Student Loans: Depending on whether they are federal or private loans, these may have varying interest rates and repayment options.

Calculate Your Debt-to-Income Ratio (DTI):

Your DTI, or debt-to-income ratio, is an accurate way to understand just how much of an impact your debt is having on your overall budget. To calculate, you will need to add up your total monthly debt payments and divide that by your total income (before taxes) which will result in your DTI.

A higher DTI indicates more difficulty in managing debt repayments which makes debt consolidation a more viable option. Generally, a DTI of 40% or less is considered manageable.

Check Your Credit Score:

Your credit score is the final number you will need to collect to determine if consolidation is the right avenue for you. They are obtainable through various free online agencies such as Equifax or Experian and will give you a glimpse at your overall financial health. Knowing your credit score will allow you to have a better idea of what options are available to you. For example, an ok credit score may mean you could qualify for a personal loan and not need to pursue a debt consolidation agency. 

Determine If Debt Consolidation Is Possible:

Now that you have a solid grasp on what you are looking at as far as overall debt, interest payments, and credit health, you can confidently decide if debt consolidation is a path that will help you out of the red and into the black. If you are still unsure, reaching out to a non-bias professional advisor should be part of the decision-making process. 

Explore Debt Consolidation Options

Debt consolidation can be a lifesaver for many women who are juggling multiple payments and high-interest rates. But, before diving in headfirst, it’s essential to explore the various debt consolidation options available to find the one that best suits your needs.

Personal Loans

If your outstanding debt is low enough, a personal loan may be an easy option to consolidate and reduce interest payments. They are often only available, however, for those people who still have a low enough DTI to be approved, meaning for some this won’t be possible. If you are able to qualify for a personal loan, transferring the balance of a high-interest credit card onto it can save a significant chunk of change!

Balance Transfer Credit Cards

If you have good credit and primarily need help with credit card balances, consider a balance transfer credit card. Many of these cards come with 0% introductory APR offers that allow you to consolidate your current debts onto one card without paying any interest during the promotional period.

Home Equity Loan or Line of Credit (HELOC)

A home equity loan or a home equity line of credit (commonly referred to as a HELOC) is another possibility to consolidate high amounts of debt personally. If you own a home and that home has available equity, you may be able to borrow against it to pay off outstanding balances. There are definitely more steps involved in this process as lenders and banks will register against your property, using it as collateral, however, this option generally will offer the lowest interest rate available.  

A benefit to this option is that many times these loans are open, meaning if you pay off the amount, you can reborrow against it in the future for various projects such as a home reno. 

Debt Management Plans

If all other options have been exhausted, it may be prudent to inquire about professional debt management plans. While they shouldn’t be your first option, it is definitely a less aggressive choice than filing for bankruptcy. When exploring this possibility, you will want to make sure you find a reputable and honest debt solution expert. Do research, talk to family and friends, and check with government officials in your area to make sure you are not falling prey to deceptive businesses looking to take advantage of those in stressful situations. 

Debt consolidation can be a great solution to reorganize your finances and diminish the amount of debt you owe, however, it should be noted that unless the underlying issues as to how and why the situation became unmanageable are addressed, lasting change won’t be found in simple consolidation.

Things to Consider when Deciding

Now that you have a better understanding of your debt situation and the various consolidation options, it’s time to make the final decision on if debt consolidation is right for you. There are various things to look at that will help during the decision-making process. These include:

Calculate the Savings:

Armed with all the numbers obtained from the previous section, you can calculate just how much money you can be saving each month by consolidating your debt. In some circumstances this number can be quite significant, and even a portion of the savings used to help pay off the principal faster than anticipated!

Compare Interest Rates:

To start, compare the interest rates on your current debts with those offered by debt consolidation loans. If the consolidation loan rate is lower, it may be a viable option to reduce interest payments over time.

Use Credit Card Payoff Calculator:

Credit card companies are obligated to inform borrowers just how long it will take to pay off their balance if only making minimum payments. While this can be eye-opening, to say the least, it is a simple way to see just how long you’ll be plugging away at your balance. 

You can find online tools that use a similar method where you can input the total amount of outstanding debt, the interest rate (or average if you want to do it as a lump sum), and the proposed payments to calculate the length of time you will be looking at. 

  • Note: While these online calculators can be useful, they are not able to account for aspects such as principal increases, potential interest rate changes, and more.

Consider Repayment Term Lengths & Monthly Payments:

Another decision that will need to be made will be about priorities. You will have to ask yourself, “is it more important to pay the debt off faster, or have lower, more affordable monthly payments”. There is no “right” answer and will heavily depend on personal circumstances. While we can most likely all agree that a shorter loan term is likely the desired choice, situations may make it necessary to choose lower monthly payments. 

The good news is, that regardless of which option you choose, you are still making progress on your journey to financial freedom! Choosing a smaller monthly payment is by no means an unwise decision, especially if that means you can avoid having to go into debt again in the future. 

Assess Impact on Credit Score:

Finally, consider how consolidating your debts will impact your credit score. Consolidation can help improve your credit utilization rate by reducing the amount of outstanding debt relative to available credit limits. However, applying for a new loan or line of credit may temporarily cause a dip in your score due to inquiries and opening new accounts.

To ensure that you’re making informed decisions about debt consolidation and its potential benefits, take time to calculate possible savings using these strategies before moving forward with any plans.

Estimating your savings is the primary step to deciding if debt consolidation will be advantageous for you. Selecting a reliable firm ensures that your finances are in good hands and heading in the right direction.

Choose a Reputable Provider

To ensure you receive the best possible terms and service, it is essential to select a reputable provider for your debt consolidation loan. With so many options available, it can be overwhelming to choose one that fits your needs perfectly. Here are some tips on how to select a reliable provider who will help you manage your debt consolidation process:

Research Providers

Start by researching different providers online, reading reviews from other customers, and comparing their offerings in terms of interest rates, repayment terms, and fees associated with their services. Enquire with those close to you for any advice they may have regarding their own experience with various providers.

Check Their Accreditation

Once you have settled on a handful of potential providers you will want to ensure that they have the proper licensing and accreditations. Not only are these accreditations a legal requirement, but you can also be sure that these organizations (ie. National Foundation for Credit Counseling (NFCC) or Federal Trade Commission) who are appropriately accredited, follow very strict ethical practices and share your goal of financial freedom. 

Compare Interest Rates & Fees

  • Interest Rates: Look for providers offering competitive interest rates lower than what you’re currently paying on your credit cards or other loans.
  • Fees: Be aware of any hidden fees associated with debt consolidation loans like origination fees or prepayment penalties which could negate potential savings from consolidating debts.

Assess Customer Service Quality

Contact customer service reps of each provider to measure their responsiveness and willingness to address queries regarding their goods and services prior to making a choice. A provider with excellent customer service will make the process of consolidating your debts much smoother and more manageable.

Consider Your Credit Score

Depending on the organization, some providers will require a minimum credit score in order to qualify for their debt consolidation loans. If that is the case and you do not meet their threshold, you can either choose to find a different provider or work on increasing your score before reapplying. 

Monitor Your Progress

Now that your debt has been consolidated doesn’t mean the work is done! For some, this is the most crucial part and can have the most lasting impact on their success. While debt consolidation is a great way to save on interest and simplify repayment plans, it is not a solution to financial issues, especially those that stem from poor money management. If your goal is to learn how to properly manage your finances and remain debt free, you will need to also have a personal journey within. 

One way to keep the momentum going is by monitoring your progress while enjoying (and celebrating) milestones along the way. In order to do this you will want to:

Create a Visual 

Watching your debt go down payment after payment is something to be seen! There are plenty of ways to create fun countdowns such as a cross-off list, countdowns on your calendar, and more. Whatever works best for you will serve as a reminder that you are working towards a goal! 

Set Additional Goals and Celebrate Milestones

Another way to continue to work toward your financial liberty is by challenging yourself to make additional payments on the principal if possible. Save up enough money to hit the goal, as well as a bit more in order to celebrate the goal.

  • Achievable Goal: Pay off $500 in credit card debt within three months.
  • Milestone Celebration: Treat yourself to a spa day or special dinner once this goal is achieved.

Adjust Your Plan as Needed

If progress stalls or unanticipated costs occur, reassess and modify your plan as necessary. Remember, staying flexible and adapting to changes will help ensure long-term success in managing consolidated debt.

Incorporating these strategies into your financial routine will empower you on the journey toward becoming debt-free. By monitoring progress regularly and making adjustments when necessary, you’ll stay on track with your goals while enjoying the benefits of lower interest rates and simplified payments through debt consolidation.

FAQs in Relation to How Does Debt Consolidation Work

How does the debt consolidation process work?

Debt consolidation is a process that involves combining multiple debts into one single loan. By consolidating your debts into one loan with a lower interest rate, you can benefit from reduced monthly payments and overall interest costs. The process usually involves taking stock of your present debt and then unifying them into one loan with a lower interest rate. Once this has been completed, you will make just one payment each month instead of several smaller ones, allowing you to save money on interest charges and simplify the repayment process.

What is the disadvantage of debt consolidation?

Debt consolidation may offer some advantages, however, it also entails certain drawbacks. Taking out a loan to pay off existing debts may result in higher interest payments over time, and thus should be considered carefully before proceeding with debt consolidation. 

Moreover, by combining your debts into one loan, it may be easier to overlook certain payments or become apathetic toward your financial state. Finally, consolidating all of your debts together could result in lower credit scores due to an increased utilization rate on any revolving accounts included in the consolidation process.

Is debt consolidation a good way to get out of debt?

Debt consolidation can be a good way to get out of debt, but it depends on the individual’s financial situation. It involves taking out one loan to pay off multiple debts and can simplify payments by reducing interest rates and consolidating monthly payments into one. However, if not done properly or with additional costs attached to the loan, it could potentially result in more debt issues later on. Therefore, before making any decisions regarding debt consolidation it is important to do research and speak with an experienced financial advisor for advice.

What are 4 things debt consolidation can do?

  1. Debt consolidation can result in a decrease in the interest rate on outstanding debt, leading to lower monthly payments and quicker payoff.
  2. It can simplify multiple payments into one single payment, making it easier to manage your finances and track progress toward paying off debt.
  3. In addition to simplifying payments, debt consolidation can provide access to resources that could help improve overall financial health in the long run.
  4. Finally, consolidating debt can potentially improve credit scores by reducing total outstanding balances and eliminating late fees associated with multiple accounts

 

By consolidating your debts, you can regain control of your finances and take the necessary steps to ensure a positive outcome. While it’s not a miracle solution, understanding the options available and doing research into reputable providers is key in determining if debt consolidation works for you. Ultimately, taking control of your financial situation through careful budgeting and strategic planning will ensure that debt consolidation work is answered positively for you.

Take control of your finances and eliminate debt with Budgetnista’s comprehensive debt consolidation solutions. With our experienced professionals guiding you, start the journey to financial freedom today!

About the Author Tiffany Aliche

Tiffany “The Budgetnista” Aliche, is an award-winning teacher of financial education, America’s favorite, personal financial educator, and author of the New York Times Bestselling book, Get Good with Money. The Budgetnista is also an Amazon #1 bestselling author of The One Week Budget and the Live Richer Challenge series and most recently, a children's book, Happy Birthday Mali More.

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