Debt isn’t foreign to most people. It’s common because it enables people to purchase items, pay for education, or get a new car without waiting to save the required amount. If not managed well, debt can escalate quickly, causing you to incur high-interest rates.
People with multiple debts often struggle to pay their bills on time. If you’re in such a situation, consolidating your debt can give you more control and effectively put you on the path to repaying your debt.
How Consolidation Works
In very basic terms, debt consolidation involves collapsing all outstanding debts into one loan. With this debt management strategy, a borrower gets a new loan at a lower interest rate and uses it to pay existing debts off. Once current obligations are out of the way, you concentrate on repaying the new loan.
By consolidating your debt, you lessen the number of repayments you have to make and the interest rates. Also, it can boost your credit score by keeping chances of missing or making payments late low.
Even so, debt consolidation needs careful consideration. If you plan to consolidate your debt, here are vital factors you need to consider:
- Presence Of Deeper Financial Issues
One of the primary factors you need to consider when consolidating debt is the presence of deeper financial issues. If you operate without a budget, have poor credit ratings or problems with spending, or devote a high amount of your monthly income repaying a specific bill, debt consolidation may be counterproductive.
Such issues require careful evaluation and strategy as opposed to debt consolidation. If you’re in such a situation and opt to consolidate your debt, there’s a chance you’ll need to take another loan to manage your debt sooner or later. Debt consolidation works well for people who can spend responsibly and have a balanced budget.
- Interest Rate Variation
The other thing you need to consider when consolidating debt is interest rate variation. A significant benefit of consolidating debt is cutting down on the number of payments you need to make every month.
This debt management strategy only works when you can lower the interest rate on your loan. Consolidating debt to reduce the number of monthly payments may not be an excellent financial decision. Ideally, a consolidation should save you funds in fees and interest.
When combining debts, focus on consolidating high-interest debts. Pursue a favorable interest rate and set up automatic payments for low-interest loans.
- Stay Away From Credit Cards
Another important debt consolidation tip you need to consider after collapsing your dates is keeping off credit cards. This is particularly crucial if you’ve consolidated your credit card debt. The temptation to start charging stuff on your credit card again is often high after consolidating the debt.
While a single purchase of a small item may not cause a significant difference in your balance, several payments can add up quickly enough and increase your loan and repayment plan.
Bear in mind that you owe a similar amount before you consolidate your debt so you can refrain from using credit cards.
- Set Up An Emergency Fund
After consolidating existing debt, one way to avoid the high-interest rates that come with credit card debt is to craft a financial plan to enable you to handle emergencies.
You can set up a savings account to help you pay for unexpected expenses, like car repairs and medical emergencies. Good practice in saving for emergencies is to start with a US$1000 pool, then gradually grow it to take care of, ultimately, a year of expenses.
- Know The Difference Between Settlement And Consolidation
Before you consolidate debt, ensure you understand how consolidation differs from settlement. Consolidation occurs when you collapse some or all existing debt into one manageable loan. On the other hand, debt settlement occurs when a creditor forgives a current debt without receiving the entire payment.
The two debt strategies reflect differently on credit score reports. Instead of ‘fully paid,’ settlements are reflected as ‘paid settled’ or ‘settled’ in the reports, instead of ‘fully paid.’ Depending on variable factors, both debt management strategies can impact your credit score ratings fast.
If you’re struggling with high-interest debts, like credit cards and multiple loan repayments, debt consolidation provides an excellent strategy for managing your debt effectively. Debt consolidation involves collapsing all the debts you owe into a single loan.
Although reducing the number of loan repayments is at the heart of debt consolidation, balancing between this and reduced interest rates is the key to realizing real financial benefits. Before you consolidate your debts, apply the five tips discussed above.