Debt Consolidation: All You Need To Know
By Debt consolidation is the act of taking out a loan or line of credit to pay off existing debt. This new loan pays off the balance owed, including interest, across your accounts. Once the original debt is paid, you begin paying off the new debt consolidation loan in equal monthly payments.
How It Works
Debt consolidation loans are powerful repayment tools because they have a lower interest rate. Most of the monthly payment you make goes toward paying off the principal, rather than the interest. This helps you save money and pay off your debt faster.
Paying off a debt consolidation loan is also comparatively simpler than paying off several loans or credit card balances. You’ll have just one monthly payment over a specified length of time.
Common Options for Debt Consolidation
Credit Card Balance Transfers: This option allows you to transfer a higher-interest balance onto a new card with a 0% (or lower) interest rate. You’ll have a limited number of months (until the introductory offer lapses) to pay off the debt at a lower rate.
Home Equity Loans: Homeowners might be able to borrow against their equity to consolidate debt. The amount you can borrow is limited by the equity you hold. This is basically the value of your property with the outstanding balance of your mortgage subtracted. The available value may be enough to pay off the debt – but falling behind on payments could cost you your home.
401(k) Loans: Some folks may be able to take out a 401(k) loan to pay off debt. However, you may have to immediately pay back the loan in full right away if you lose your job. Additionally, during the repayment period, you may miss out on market increases that can boost your retirement fund.
Personal Loans: Taking out a personal loan is another way to consolidate debt. However, people with bad credit scores may not qualify for a low-interest loan. In that case, going this route may not be an option. A debt consolidation loan only makes financial sense if you’re able to secure an interest rate that’s lower than what you’re currently paying.