ls Consolidating Your Debt With A Personal Loan Right For You?
Posted On October 6, 2021 · Length of read: 5 minutes
Debt could have both a financial and an emotional impact on your life. Sometimes, it’s not just about the dollar amount that you owe but also the number of bills that you need to keep track of each month.
If you’re sick of logging into five or more accounts on different dates, you might be ready to get a personal loan for debt consolidation.
What Is Debt Consolidation?
Debt consolidation loans allow you to take your existing debt and refinance it into a new loan with a single monthly payment. After refinancing, you then continue to make loan payments on just one account.
Some people are attracted to the idea that they could turn their bills into one consistent monthly payment. It could make debt easier to manage – and potentially pay off if you stay on top of your payments every month.
Shopping for a personal loan with a lower interest rate may be a viable option for dealing with your debt. When you find a personal loan with a competitive Annual Percentage Rate (APR) and use it to pay off your other debt, it could lower your total payments over time.
Many people use debt consolidation to pay off high-interest credit card debt or other types of loans. However, while the process of debt consolidation is one way to help with debt repayment, it does have both benefits and drawbacks.
Benefits of Consolidating Your Debt With a Personal Loan
Since the goal of consolidation is to eventually eliminate your debt, you may want to keep your credit cards on a high shelf until your loan is paid off. When you’re in control of your spending and credit usage, you could enjoy the pros of debt consolidation:
- Your debts will be simplified into one monthly bill.
- Your monthly bill may be smaller than your bills were before you consolidated.
- You may pay a lower interest rate, which means you could save money in the long run. However, this depends on the repayment terms of the loan and your credit history.
Drawbacks of Consolidating Your Debt With a Personal Loan
Debt consolidation has some drawbacks if you are not a responsible spender or have a low credit score.
You may encounter some of these cons to taking out a personal loan for debt consolidation:
- If you don’t use the funds to actually pay off your credit cards, you’ll just be in more debt.
- You could pay off all of your credit cards and then use them again in a moment of weakness.
- If you have a low credit score, you could get a personal loan with a high interest rate. If you do have a low credit score, you may want to work on increasing it before applying for a personal loan.
- Extra fees are sometimes associated with personal loans like origination fees, prepayment penalties, and more.
When You Could Consider Debt Consolidation
There are certain financial situations that are most appropriate for a debt consolidation loan. Borrowers who meet these criteria often find it easier to secure a personal loan to pay off debt, as well as to make the monthly loan payments.
In general, a debt consolidation loan makes sense financially if:
- You qualify for a lower interest rate. A debt consolidation loan should always save you money. If the interest rate is higher than your current average interest rate, you probably should not take on the loan.
- You could consolidate all of your debt into a single personal loan. If the number of monthly payments is a primary concern, a debt consolidation loan doesn’t make sense unless it combines all of your payments into one. Otherwise, you’re still dealing with multiple payments, which could quickly become overwhelming.
- You could lower your monthly payments. Overall, your goal is a single monthly payment that’s lower than all your current monthly payments combined. Even if you secure a lower interest rate and consolidate all your debt into one loan, debt consolidation doesn’t help you financially if the monthly payment is more than you’re paying now.
So, how could you tell if a personal loan will help you financially? First, review the list above. Next, review your finances and creditworthiness.
Personal loan lenders are more likely to approve borrowers with an excellent or good credit score. Lenders like to see a proven track record of on-time payments before they extend additional credit.
When You Could Not Consolidate Your Debt With a Personal Loan
- You have bad credit. While your credit history isn’t a reflection of your value as a person, lenders rely on this report to determine your creditworthiness. Bad credit may actually make you spend more money long-term since you’ll probably qualify for the highest interest rates or loan terms.
- Your total loan amount would be too small. The goal of a debt consolidation loan is to make your debt more manageable. If you don’t have much debt, it’s usually best to just pay it off quickly. Otherwise, you may face a prepayment penalty when you pay the personal loan off too fast.
- You have too much debt. Likewise, too much debt could be a red flag for a lender. If you have an overwhelming amount of debt, consider reaching out to debt relief companies or seeking credit counseling instead.
Alternative Debt Repayment Methods to Personal Loans
If getting a personal loan to pay off debt doesn’t seem like the best idea right now, please don’t worry. There are other repayment plans you could consider in 2022 and beyond.
Here are the top three alternative repayment methods:
- Credit Card Balance Transfers
- Debt Snowball Method
- Debt Avalanche Method
These aren’t loan options, but they are effective ways to pay down your debt until it’s a more manageable amount. As you pay down your debt, you may find yourself in a situation where a personal loan makes sense, so review your plan and revisit your options throughout your debt payoff journey.
Credit Card Balance Transfer
If you have multiple credit cards, you’ve probably noticed an option to transfer your debt from one credit card to another. There may be a balance transfer fee associated with this option, so pay special attention to the fine print. Look for a balance transfer credit card to start the process.
When you open a credit card with a lower interest rate and transfer the loan balance from your existing cards with higher interest rates, you could pay down your debt more quickly while also boosting your credit score over time through timely payments.
Many financial experts tout the potential benefits of the debt snowball method. This method is a pretty simple strategy for paying off debt strategically.
First, list your credit cards in order from the one with the lowest balance to the one with the highest balance. This helps the debt seem more manageable.
Make your minimum monthly payments on each card, then pay a larger sum towards the card with the lowest balance. Continue this process until you’ve paid off the first card, then repeat with the next lowest balance.
As you pay off each card, you’ll free up more cash in your budget, creating the “snowball” effect. If you struggle with motivation, the debt snowball method is a one way to pay debt down quickly.
The debt avalanche method is similar to the debt snowball, but the mentality is a little different. First, list your debts in order from the one with the highest interest rate to the one with the lowest interest rate. This method focuses on financial savings.
Just like the debt snowball method, pay the minimums on all your cards except the first one. In this case, it’s the card with the highest interest rate. Pay more than the minimum on this card, and once you pay it off, continue to the next one on the list.
This method saves money in interest, which makes your debt more manageable over time. If you want to pay less interest over the life of the loan, the avalanche method is the way to go.
Choosing a Personal Loan for Debt Consolidation
So, where to begin your debt consolidation quest? You could start by checking the Annual Percentage Rates (APRs) on your existing debts. Find out which one has the lowest APR, and then make it your goal to find an even lower APR on a personal loan.
Next you’ll want to find a lender that offers debt consolidation loans. These lenders fall into multiple categories but the most common examples are online lenders, banks and credit unions.
Splash Financial is one example of an online lender that can provide personal loans to those looking to consolidate debt. If you’re in good credit standing and in need of debt consolidation, review some of the offerings that might be available to you.
The information provided in this blog post is not intended to provide legal, financial or tax advice. We recommend consulting with a financial adviser before making a major financial decision.