Debt consolidation is one of the ways you can tackle your debt. Debt consolidation helps simplify your payments by rolling your multiple bills into one payment and it can often lower your interest rate and help you get out of debt faster. However, if you want debt consolidation to work then you need to know the debt consolidation truths and myths.
Debt Consolidation: Myths and Truths
There are a lot of misconceptions about using a loan for debt consolidation. Knowing debt consolidation truths and myths can help you make the right decision for your financial situation.
Top Debt Consolidation Myths
There are a lot of beliefs about debt consolidation. Is debt consolidation expensive? Does debt consolidation impact on your credit score? Keep reading and get answers about these questions about debt consolidation myths.
Debt Consolidation Reduces Debt
One of the biggest debt consolidation truths and myths is that it doesn’t actually reduce your debt. Your debt also isn’t forgiven and instead you are paying off your whole debt with a loan. If you want to eliminate or reduce your debt then you need to look into debt settlement, which usually involves hiring a debt settlement company to work with your creditors to reduce your debt. This may sound like a better option and a good choice but it usually destroys your credit and can be costly. This is why debt consolidation is often chosen instead of debt settlement, despite different debt consolidation truths and myths out there.
You Always Will Save on Interest
One of the reasons many people choose debt consolidation is because it lowers your interest rate but this isn’t always the case. Beware of the debt consolidation truths and myths so that you don’t get into a worse financial situation and end up with an even higher interest rate. If your credit is strong then you may get an interest rate on a loan that is actually lower than your rate on your current debt. Total interest costs can increase if you extend your repayment terms.
Use a debt consolidation loan to calculate this and see how different rates and loan repayment terms can impact your payments. It also helps to see an example. If you have an interest rate of 15% on your $20,000 in debt and you are paying $600 a month then you end up paying $25,800 over about 3.5 years. However, if you use a debt consolidation loan that has an interest rate at 10% that you take seven years to pay off, your payment is much lower at $332 but your total payment will be $27,890. As you can see, your payments are lower, as is your interest rate, but you will be paying more in the long run.
When You Do Debt Consolidation Your Credit Score Will Suffer
Can debt consolidation impact on your credit score? The truth is that you will need a hard credit pull when you are getting a loan for debt consolidation. However, this will usually only drop your score by a few points and isn’t usually a big deal. Depending on how debt consolidation works for you, you may actually improve your credit score since you are better able to pay off your debts. Any short term hit to your credit can be worth it if it can allow you to stay on top of your debt repayment plan and actually be in a better financial situation.
Debt Consolidation Is Expensive
The interest rate on loans you use for debt consolidation can vary due to different factors, including your lender, but on average they are lower than the average interest rate on a credit card. Many loans don’t have any extra fees. However, some loans do have origination fees to cover loan processing or fees for late-payments so it’s important to do your research if you are looking to save money, be sure to shop around. Find a lender that won’t charge a fee for paying off your loan early. Check the APR, which includes the origination fees, to make it easier to compare costs when researching different lenders.
Debt Consolidation Is Time Consuming
Many lenders use an online loan application process that will allow you to go through the process quickly using a secure online portal. The entire process, from your application to the funding of money, may only take a few days to a week. Some people think that you have to go back and forth with a lender and have a lot of meetings but you don’t have to do that. Preparing documents, such as bank statements, before applying can make the process even faster. While this won’t change your rate, you can get your money quicker and pay off your debt to start saving.
Debt Consolidation Is a Scam
Debt consolidation is a credible way to pay off your debts but you do want to make sure you do your research when it comes to getting a loan. There are predatory lenders that have popped up and are taking advantage of people who find themselves in a lot of debt.
Debt Consolidation and Debt Management Plans Are the Same Thing
When learning about debt consolidation truths and myths, it helps to understand the difference between different debt options. Debt management plans don’t have a loan. There is one monthly payment but it’s a program offered by a credit counseling agency. The counselor will calculate the payment you can afford and determine how long it takes to eliminate your debt. You then send the monthly payment to the credit counseling agency and they will distribute the funds to each creditor in an agreed amount. Since credit counseling agencies work with creditors regularly there are agreements in place to help lower your interest rate and waive penalties.
Debt Consolidation Leads to More Debt
It is true that debt consolidating won’t fix the root of your problem. Yes, it can wipe your debts clean but if you haven’t changed spending habits then you will likely end up in the same situation again. A debt management plan does require credit counseling, which is designed to change your behavior. With debt consolidating, you may not have credit counseling but there are tools available online to help you create a budget and information about best practices, such as creating an emergency fund.
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You Have to Pay to Consolidate Debt
There may be origination fees with the loan you choose for debt consolidation but that that won’t necessarily be the case. There are balance transfer credit cards with no transfer fees and no interest so if you are able to pay down your debt during this window, you will not have to pay anything for debt consolidation. Use caution if you are working with a company that is charging to consolidate debt with you. You don’t have to work with these companies and it’s easy to go through the process on your own without the guidance of these companies that will charge you money.
Top Debt Consolidation Truths
While there are plenty of myths to be aware of, there are also a number of debt consolidation truths you need to know.
You Are Working with a New Lender When You Consolidate
When you get a debt consolidation loan, this usually means you are working with a new lender instead of the lenders where you have current debt. This isn’t a bad or good thing but it means that you need to understand the terms of your new loan and make sure that you know any rules that are unique to the lender. This is why shopping for the right personal loan and debt consolidation is so important so you find one with the right interest rate for your credit and the right terms you can live with. Missing payments is going to make your financial situation worse so you need to make sure you can make the payments.
Debt Consolidation Loans Can Be Secured or Unsecured
Some debt consolidation loans can be secured with collateral that you have. This can be things such as a car, business, or home. Secured loans may have a lower interest rate and can be easier to qualify for. Secured loans also come with greater risk because if you default on the loan then the lender can take the collateral. Not having any collateral can make it harder to qualify for a loan if your credit isn’t good. It may make sense for you to put up some collateral as long as you are aware of the risk.
You Can Use Home Equity Loans and Personal Loans for Debt Consolidation
Personal loans come with a fixed interest rate so they are usually an attractive option. There are many places to shop for online debt consolidation loans. With this type of loan, you get to pay off your debt with the knowledge that payments stay the same. Home equity loans do require your home as collateral. However, the interest rate on the loan can be even lower because you have that collateral. There can be fees for different loans. A home equity loan may have fees for the lender to appraise the value of the home or closing costs for the loan. Personal loans can have an origination fee. Be sure you are learning about any fees first so you can evaluate the total costs and decide if it’s the right choice for you.
Balance Transfers Could Be an Option for Debt Consolidation
A credit card company may want to attract new members by offering good deals on balance transfers. This means you may be invited to transfer your balance from other cards with low or even zero interest. This could be a good choice for consolidating higher-interest credit cards. It’s important to note that a credit card still needs to be paid on time. At the end of the promotional balance transfer period, the interest will become higher, which increases the amount of interest you are going to pay each month. If you do choose this route then you need to pay off as much as possible under the promotional rate in order to take advantage of the offer.
Your Credit Will Influence Your Debt Consolidation Options
As with any type of loan, it’s important to note that a better credit score opens up more options for you. Better credit will give you a better option, along with better terms. If you are looking for debt consolidation assistance then chances are your credit may not be that great. But there are still options for debt consolidation with your bad credit. It will likely cost you more and you may only qualify for a secured loan. If these are your circumstances then you will need to figure out if it’s the best option for you. While you don’t need perfect credit, it does help.
Evaluate Your Options for Debt Consolidation
Obviously, paying off your debt is the best thing to do. Debt consolidation may work for you but it’s not for everyone. If your debt balance is relatively small, it may be a better option to just stick to a budget and pay off the accounts you have. Other types of debt, such as student or auto loans, may be a better option for refinancing. If the cost of debt consolidation is going to drive up the payments on your loan then it may be better to look at alternative choices.
How Does Debt Consolidation Work?
When learning about the debt consolidation truths and myths, it helps to know how the process works. The process isn’t that complicated but it does require that you do your research at the appropriate steps so you know what you are getting into.
- Step 1: Determine which debts you want to pay. It’s best to consolidate store cards, credit cards, gas cards, and medical bills. You likely don’t want to consolidate debts like your home but you can also consolidate federal and private student loans, depending on the amounts.
- Step 2: Review your loan offers. Compare the different loan offers when you are looking for an option to pay off your debt.
- Step 3: Start paying down debt. Now that you have the loan or balance transfer option, make sure that you pay off the debt. Stay determined to pay off the balance and then make sure you make your loan payments on time and work on a budget so you don’t get into debt again.
Questions About Debt Consolidation
Part of debt consolidation truths and myths are the unknowns and confusion surrounding the process. It helps to know the answers to some of these questions.
What Kind of Debt Can You Consolidate?
Whether you choose a balance transfer or loan, you are able to consolidate credit cards, gas cards, or high-interest loans. You are also able to consolidate your student loans.
Does Debt Consolidation Help You Pay Down Debt Faster?
The answer to this question will depend on your unique financial situation. The reason there is so many debt consolidation truths and myths is that each situation is different. Debt consolidation can help lower your monthly payment but it might also decrease the amount of interest you pay. The ability to make your payments on time will be important to pay down your debt in the long run.
How Much Debt Can You Consolidate?
This will depend on the amount you are approved for with your loan. The better your credit score, the more likely you are to get approved for a higher amount.
Do You Pay Your Creditors Directly?
With a debt consolidation loan, you will pay off your creditors directly and then pay off the balance on your loan according to the terms.
How to Avoid Getting More Debt?
One of the main debt consolidation truths and myths is that it’s not a magic solution. It can help you pay off high-interest debts but you do need to make some lifestyle changes so you don’t end up with even more debt. Before you go through the debt consolidation process, there are a few things you want to do.
Identify Your Root Problem
Review your statements to see where are you overspending your money. For example, you may find that you are spending too much money eating out or are going on too many shopping sprees. Once you look at the root causes then you are able to make some adjustments.
Create a Budget
Coming up with a realistic budget and sticking to it is the next step after you take a look at your spending habits. A budget is about setting limits and you want to avoid carrying a credit card balance from month to month. Remember that each month you carry a credit card balance you are paying interest on this money. Use credit cards for only emergencies and stick with the budget you have.
The process of repaying your debt can take months or sometimes even years. Stay focused through the process and be diligent about sticking to your budget so you can get into better financial health. Review your statements regularly so you are holding yourself accountable. It helps to have your financial goals and progress in mind.
Debt consolidation can be a good option if you have some trouble with debt but you need to know about debt consolidation truths and myths. Debt consolidation truths and myths have made the process more confusing over the years. Usually, most people with bad credit needing debt consolidation loans. There are a lot of debt consolidation questions but the process doesn’t have to be all that complicated. Once you go through the process, you need to avoid getting in the same situation and in more debt.
Jackie Strauss is a finance writer with a background in economics living in Los Angeles. She has a passion for helping readers learn more about personal finance, insurance, home loans and paying down debt. As a college student during the Great Recession, she has had to learn budgeting and money saving techniques to become a new homeowner.