One frustrating aspect of debt is simply the amount of effort it takes to stay on top of payments — especially when you’re juggling multiple accounts spread out across a handful of creditors. Considering the fact the average American family has four credit cards, it’s safe to say many U.S. adults are dealing with the task of managing multiple accounts month after month.
As the name implies, debt consolidation is a strategy that aims to do two things: streamline the actual process of making payments and reduce the number of interest borrowers end up paying. Many consumers have found some form of debt consolidation helpful in simplifying their debts and making them more affordable.
However — like any debt elimination strategy — consolidation is not necessarily the best option for everyone, nor is it a foolproof plan. Before you decide to try debt consolidation for yourself, it’s worth asking these five questions.
What Kind of Debts Do I Have? How Much Do I Owe?
The first step is simply taking stock of your debts to establish their types and amounts. Make sure you include every account from the get-go so you can gain an accurate understanding of your financial situation.
Debt consolidation is a possible tactic for dealing with unsecured debts specifically — those without a physical asset attached, like credit cards, medical bills, utility bills, and payday loans.
Which Form of Consolidation Makes the Most Sense?
There are a few distinct forms to try on for size.
- Consolidation loan: Banks, credit unions and debt consolidation companies offer loans, which can be used to cover other high-interest debts. This can lower the amount of interest you’ll pay and leave you with just one monthly payment for however long the loan lasts.
- Balance transfer credit card: You may be able to transfer the balance from a high-interest credit card account to an introductory card with zero or low interest. This gives you a window in which to pay down your balance without racking up more interest charges, after which the interest rate generally jumps back up — often quite substantially.
- Cash-out refinance: Homeowners may be able to refinance their homes. This increases the amount of their mortgage, but it also frees up the difference in cash for debt consolidation. The major risk here is increasing your mortgage. Also, missing payments could result in a foreclosure on your home.
How Much Money Can Consolidation Potentially Save?
One major factor determining whether debt consolidation is a worthwhile endeavor is the amount of money you could potentially save through this strategy. This means calculating how much you’d pay in interest if you tried to pay off your debts on your own vs. how much you’d pay if you pursued a certain form of consolidation.
Say you’re considering taking out a personal loan to pay off five credit card balances. You’ll need to know the interest rates for both strategies, as well as the loan term and monthly payments. Then you can compare. It may be worth pursuing if your calculations reveal consolidation would save you a chunk of change over do-it-yourself repayment.
Your credit score and payment history will play a pivotal role in determining both your approval status for a consolidation loan and the interest rate, so anything you can do to strengthen your credit will help you in this department.
Can I Avoid Accumulating Additional Unsecured Debt?
Last but not least, it’s smart to determine whether you can avoid accumulating additional unsecured debt while you’re working on what you currently owe. If the answer is no, debt consolidation can dig you into a deeper hole.
Since debt consolidation is a strategy that streamlines the actual process of making payments and reducing the interest lenders end up paying, there is a need for caution, though!
Thinking about trying debt consolidation? Lay the groundwork for your success by asking these five questions.