What Do I Need to Know about Debt Consolidation?

Q: I’m up to my ears in debt, and I’d love a way out. I’m strongly considering debt consolidation. What do I need to know before I move ahead?

A: Debt consolidation is the process of moving several (possibly) high-interest debts into a new loan or line of credit. It can help you pay off your debt quicker, with less money going toward overall interest payments.

Here’s what you need to know about debt consolidation.

What are the benefits of debt consolidation? 

Saving on interest payments. The biggest benefit by far is saving on interest costs. Long-term debt with a high interest rate can cost thousands of dollars in interest payments over the life of the loan. That’s money you may not need to pay! Moving that debt to a new loan or line of credit with a lower interest rate, or sometimes no interest rate at all, can translate into significant savings.

Simplified payments. With just one monthly payment to make, managing your debt will be a lot easier.

Fixed payment timeline. Debt consolidation often means having a fixed payment timeline. This makes budgeting easy and allows you to make long-term financial goals, with a fixed date for when you finally will be debt-free.

Boost your credit score. If you’ve been falling behind on your monthly payments, moving your multiple debts to a single low-interest loan can help to boost your score.

What are the disadvantages of debt consolidation? 

May prolong the payment timeline of the debt. Moving debt to a new loan can sometimes involve extending the term of the loan. If that happens, then it will take longer to pay off your debt.

Doesn’t eliminate irresponsible spending habits. If overspending and reckless money management is what landed you in debt in the first place, consolidating debt on its own will not solve the problem.

Lower interest rate may not last. Many low- or no-interest credit cards only offer these features as a temporary promotion. Once an introductory period ends, be prepared for rates to jump higher.

How can I consolidate my debt?

You have several options for debt consolidation, each with its own advantages and disadvantages.

1. Unsecured loan. Taking out an unsecured loan will enable you to pay off all your outstanding loans immediately and move your debts into one low-interest loan.

At some financial institutions, unsecured loans may have origination fees and other charges. Also, since they don’t require collateral, the interest rates on these loans can be higher compared to secured loans.

Lucky for you, though, as a member of Scott Credit Union, you have access to personal loans with no origination fees and competitive interest rates.

2. Home Equity Line of Credit. A HELOC allows you to tap into the equity of your home to draw money as needed. The amount you can borrow will depend on your home’s total value, the percentage of that value the lender allows you to borrow against and how much you currently owe on your home. Since it is backed by a valuable asset (your home), a HELOC is secured debt, which will usually have a lower interest rate than unsecured debt such as credit cards.

The drawback of using your home as collateral to help you pay off debt is that you risk losing your home to foreclosure if you fail to meet your payments. Also, if the value of your home drops, you may end up owing more on your home than what it is worth.

Interest on HELOCs will be affordable and may provide you with significant savings. That interest is sometimes tax-deductible as well. (Please consult with your tax advisor to discuss potential tax savings.)

3. Balance transfer. Moving your debt to a new credit card will make it possible for you to pay off your debts immediately. And, if the card has a low- or zero-interest introductory offer, you’ll save money and avoid accumulating more debit as long as you make dutiful payments during the introductory period.

But be careful—if you’re prone to overspending, don’t let yourself be tempted into racking up more debt with your expanded available credit. Also, as mentioned, you may face higher interest rates once the introductory period ends.

Fortunately, as a member of Scott Credit Union, you can take advantage of our low-interest credit cards to help you get rid of your debt quicker.

If you’re ready to consolidate your debt, we can help! Call, click or stop by today to discuss your options.

Your Turn: Do you have experience with debt consolidation? Tell us your best tips in the comments.