Most people carry debt from time to time. In some cases, debt may become unmanageable and you may seek out alternative methods to regain control over your finances. Debt consolidation may be a good option for those exploring better ways to manage debt. Consolidating means repaying multiple existing loans, such as credit cards and other loans, with one new loan.
Debt consolidation can be a beneficial tool when used appropriately. We’ve put together a list of common mistakes you should avoid.
Ignoring Other Options for Paying Off Debt
If your credit score is low or your financial situation isn’t good, you might be better off opting for another strategy, such as credit counseling. Those with low credit scores may only be able to get a debt consolidation loan with a high interest rate which could cancel out the benefits of using this tool entirely.
In addition to offering clients a plan to restructure and pay off their debt, credit counseling offers benefits that a simple debt consolidation product cannot provide. For example, budgeting advice is handy for clients who need it.
You can also borrow against assets, such as a 401(k) or your home equity. Again, bad credit borrowers often benefit from these loans due to their lower APRs.
Choosing the Longest Possible Term
Extended repayment periods may tempt you, but you may want to avoid them. While you pay a lower amount in every installment since you are dividing the payments across a longer term, you’ll ultimately pay more in interest.
Find out what options are available from your lender. Go for the shortest duration possible if your income is steady and you can afford higher monthly payments. Your interest payments will be reduced significantly if you do this. Additionally, you can more quickly eliminate your debts.
Avoiding the Root Causes of High Debt
The purpose of debt consolidation is to make debt management easier. A debt consolidation loan, however, only provides a temporary solution to debt problems. So instead, reflect on what led you to accrue debt in the first place.
Debt can pile up because of poor financial habits. Start by re-evaluating your budget and get a clear view of your income versus what you spend. Separate expenditures into necessities and “extras” and see where you can cut back on things you don’t need.
Getting to the root cause of debt can help ensure you don’t wind up in the same place in the future.
Choosing the Wrong Consolidation Loan
Most borrowers can secure a personal loan for debt consolidation, even those with bad credit. But that doesn’t mean you should take out any loan.
The best loan is one that has a lower annual percentage rate (APR) than the average interest rate of all the debt you currently carry. You can use an online debt consolidation calculator to help you do the math. Don’t gloss over the repayment term, either. Remember, a longer term has lower monthly payments, but it also means you remain in debt longer. Aim to pay off the debt over a three- or four-year term. This ensures you can move on to other financial goals sooner rather than later.
Debt is a reality for most people worldwide. And while credit, when used wisely, is helpful, many people find themselves overwhelmed. So when you require debt consolidation, make sure that you avoid the most common pitfalls.