There are a lot of different strategies you can use to pay down debt. One option is to pay off your debts with a consolidation loan. Before you decide if this option is a good fit for you and your financial situation, you should learn about the pros and cons of debt consolidation.
When you take out a debt consolidation loan, you use the money you borrow to pay off other debts, such as credit card balances. Once the debt consolidation loan is active, you only make one monthly payment rather than having to pay several different lenders.
The benefits of debt consolidation
In addition to making just one payment each month, there are several advantages to consolidating your debt:
- Lower interest rate and fixed payments - The interest rate you get on a debt consolidation loan may be lower than the rate you’re paying on your existing debt, which can save you a significant amount of money over time. In addition, if you choose a loan with a fixed interest rate, then your payment due each month will remain the same as you pay off your loan as scheduled. That can make budgeting easier.
- You know when you'll finish paying off your debt - A loan has a set amount of time during which you’ll be paying back your debt. With a credit card, there is no set date when you know you’ll be finished paying off your debt and you can continue to use your card, which can increase your total balance and the amount of interest you’ll pay.
- You don't have to put any collateral at risk - With some types of loans, like home equity loans or vehicle title loans, you have to use your home or vehicle to guarantee that you’ll pay the loan back. If you don’t pay it back, the lender can sell your collateral to pay off the loan. If you opt for an unsecured debt consolidation loan, you don’t have to use your home or vehicle as collateral.
The downside of debt consolidation
There are some cons you should also take into account before choosing debt consolidation, including:
- Higher interest rates, fees or closing costs - Be sure to compare the fixed interest rate on a debt consolidation loan to the rate on your existing debt to ensure that it is lower. Also, some lenders charge application, origination, and other fees. Before you sign on the dotted line, ask the lender to tell you if there are any fees associated with the loan and the total amount you’ll pay in fees.
- Payments can be higher - Because you have a set amount of time to pay off your loan, your monthly payment may be higher than when you were paying the minimum possible amount on your debts before consolidation. Make sure the payment on your loan won’t strain your budget before deciding to consolidate your debts.
- A loan may not solve your underlying financial issues - If you consolidate your existing debts, but continue to overuse your credit cards, the loan won’t put an end to your debt problem. You also need to make a budget and change any spending behaviors that contribute to your debt.
By considering the pros and cons of debt consolidation, you can decide if it’s the right strategy to help you get on track to a stronger financial future.