When Debt (Loan) Consolidation Makes Sense

What is Loan Consolidation

Loan consolidation is the process of taking the proceeds of a single loan to pay down or pay off two or more debt balances that may require multiple monthly payments.

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When Debt (Loan) Consolidation Makes Sense

Debt consolidation is only a logical step when the following factors are met:

  • The total number of payments can be managed responsibly.

  • The new loan doesn't lengthen the amount of time to pay off the debt

  • The interest rate isn't higher.

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Benefits of Loan (Debt) Consolidation

When a household feels stuck with several credit card payments, and many other loan payments consuming the majority of their income, loan consolidation may be beneficial. It can help create some room in the budget by consolidating the number of payments into one monthly payment.

A debt consolidation loan can take several monthly payments and combine those payments into one payment, making it easier to budget and track.

It may increase your credit score. If you have credit card debt that consumes that majority of your credit utilization, a consolidation loan can help pay these off or pay down. This will increase the amount of credit available on the card; however, this isn't a green light to put more credit on the card.

Other than the reasons listed above, the cons outweigh the pros and read below to discover why.

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Cons of Consolidating Debt

Many applicants applying for a consolidation loan are generally thinking about the short-term. They feel stuck and need immediate relief. Before one applies for debt consolidation, here are several alarming things to know:

  • A consolidation loan generally takes longer to pay off than the original debt.

  • The interest rate is almost always higher than the original debt.

  • It takes longer to pay down the monthly interest before any principal deductions become evident.

  • Debt consolidation doesn't equate to eliminating debt.

  • Getting a consolidation loan doesn't address the poor money management or budgeting habits occurring within a household.

How to Consolidate Your Loans with Bad Credit

It shouldn't come to a surprise to discover that debt consolidation or getting a loan to consolidate your debt is far more complicated when one has a bad or a poor credit score.

The biggest concern of getting a loan with a low credit score is it defeats the purpose of lower payments because the interest rate alone will be roughly around 30%!

The most current interest rates seen for debt consolidation are ranging from 28% to 36%. That means the applicant will be making interest payments only for a significant period without ever seeing any payments being applied to the principal amount (meaning takes very a long time to pay off).

The other concern is the hefty fees and penalties that will be applied to the loan, thus making it even more difficult to pay down the loan. And let's be honest, if the applicant has poor credit, then it reasons to believe that at least one late payment is likely in one's future.

I strongly advise against getting a consolidation loan unless you can get a very low-interest rate, fixed only. Also, you shouldn't get a debt consolidation loan unless you have changed money management behavior. Are you living outside your budget? Do your expenses exceed your income?

Instead, get a plan to pay off your debt. Create your own debt-relief plan. When you have skin in the game, it transforms your behavior and spending habits because the pain of hustling reminds you of the costs it took to get out of debt.

For instance, you may need to pick up a second job or a few side hustles. These extra hours hustling to make some extra income is a terrific way to get your finances in order if you're struggling to lower your expenses or live within a budget. Also, a few extra dollars toward debt goes a long way.

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