A debt consolidation loan lets you combine your credit card balances, loan balances and other bills into one manageable payment. It is a convenient way to deal with your outstanding balances, and if you are tired of juggling different creditors each month, debt consolidation is a convenient way to simplify your finances and get organized.
How Does a Debt Consolidation Loan Work?
There are several ways to obtain cash to consolidate your outstanding balances. You can apply for a personal loan, or use the equity in your home to get a home equity loan or cash-out mortgage refinance. Prior to applying for a loan, you will need to provide your lender with a list of your creditors and your account balances. The lender will check your income and credit, and based on this information, decide whether to extend financing. If you are approved, the lender cuts a check for a lump sum, and you pay off your bills and credit cards with this money. You then make a payment to your lender each month to pay off the debt consolidation loan.
What to Consider When Applying for a Debt Consolidation Loan?
Shop around for the best interest. To get the most out of your debt consolidation loan, the interest rate on your loan should be less than the interest that you’re paying on your other debts. For example, if your average credit card has an interest rate of 19%, look for a debt consolidation loan that charges far less. A lower interest rate helps lower your monthly payment and helps you pay off the debt consolidation loan faster.
Borrow only what you need. If applying for a home equity loan or cash-out refinancing to consolidate your debts, there’s the temptation to borrow more than you need. However, cash borrowed against your equity is not free money. Not only do you have to repay a home equity or cash-out refinance, but these consolidation options increase how much you owe on your house. Default on either type of loan and you could lose your house.
Be disciplined. Debt consolidation is dangerous because you can potentially double your debt. Once you have paid off your credit cards and other bills with a debt consolidation loan, adopt smart spending habits to avoid re-accumulating balances. For example, if you pay off a credit card with funds from a consolidation loan, do not put additional charges on the credit card. The purpose of a consolidation isn’t to free up your credit cards for new purchases, but rather to better manage your debt. If you make a purchase with your credit card, always pay the balance in full each month.