What Is debt consolidation? If you’re struggling with credit card debt, you’re certainly not alone. According to credit reporting bureau Experian, the average American has a credit card balance of $4,293. Because credit cards can have incredibly high interest rates — some as high as 30 percent — your credit card balance can quickly balloon out of control.
When that happens, it’s easy to feel overwhelmed. But there are ways you can tackle your debt and save money, helping you pay off your credit cards early.
Debt consolidation is one option. With debt consolidation, you move the debt to a lower-interest type. More of your monthly payment goes toward principal rather than interest, allowing you to save money and pay off your debt faster.
Debt consolidation works in several different ways, but there are two core types:
● Personal loan debt consolidation: With this approach, you take out a personal loan for the amount of your debt. The loan will likely have a lower interest rate than your credit cards, and it will have a fixed monthly payment and repayment term.
● Balance transfer debt consolidation: Instead of taking out a loan, you can simply transfer your credit card balances to a new credit card with a 0 percent interest annual percentage rate, or APR, offer. During the promotional period, you’ll have up to 15 months to repay your balance without worrying about interest fees.
Debt consolidation can help you save a significant amount of money. For example, let’s say you had $5,000 in credit card debt at 26 percent APR and had a monthly payment of $125. If you made only the minimum payment, it would take you nearly eight years to pay off and you’d repay a total of $11,625 — more than double what you originally charged.
Now, pretend you consolidated that debt by taking out a $5,000, three-year loan and qualified for a 9 percent interest rate, your monthly payment would be $159. Higher than $125 but you’d be completely debt-free within three years instead of eight. And, you’d repay a total of just $5,724. Opting for a debt consolidation loan would allow you to save nearly $6,000.
Debt consolidation makes sense when you have high-interest debt, such as credit cards, but still have relatively good credit and can qualify for a low-interest loan or credit card. It allows you to set a payoff date on your calendar and know that you’ll be debt-free by that time.
It’s not a good idea when you have poor credit, since the only loans or credit cards you can qualify for may have very high interest rates, worsening the problem.
Most important, debt consolidation doesn’t solve your problem by itself. It simply moves your debt to another source with a lower rate; you still have to pay it off.
Before moving forward with debt consolidation, make sure you take the following four steps:
- Identify the root problem: If you don’t address the causes of your debt, you’ll just end up racking it back up again. Take some time to reflect on what caused you to get into debt in the first place. Perhaps you eat out because you’re short on time or go on shopping trips as stress relief. By addressing these issues now, you can help prevent debt from piling back up.
- Create a budget: Sit down and write up a budget, listing all of your income and current expenses. If you’re spending more than you make, you’ll have to make some tough choices.
- Make cuts and increase your income: Once you have a budget, look for areas to cut back. Perhaps you can cook at home instead of eating out or will vow to cut back on clothes shopping. Also, look for ways to boost your income, such as asking for a raise or launching a side hustle, to bring in more money.
- Stick to a plan: Once you’ve created a budget, made cuts to your lifestyle, and worked toward improving your income, make sure you stick to the plan and stay focused. Write down your goals to help remind yourself of where you want to be.
Debt consolidation can be a powerful tool that can help you tackle your debt head-on. By decreasing your interest rate, debt consolidation allows you to save money and pay off your debt ahead of schedule, giving you peace of mind. But, before taking out a debt consolidation loan or applying for a new credit card, make sure you’ve done your homework and are ready to make a lifestyle change to manage your debt.
