You’ve got a bunch of debt and you’re not sure what to do. Well, you may be a good candidate for debt consolidation – IF you can get an interest rate that’s lower than what you’re paying on current debt. The financial strategy can help lower your overall debt and restructure it so you can erase it quicker.
But is it smart to get a debt consolidation loan? Let’s discuss.
Consolidating Your Debt
The top two ways to consolidate debt are through a balance transfer credit card and a debt consolidation loan. The best choice for you depends on your credit and your debt-to-income ratio, which compares how much you owe monthly to how much you earn.
- Balance transfer card. You’ll need a credit score of at least 690 to pull it off, but this type of consolidation involves shifting your high-interest credit card debt onto a card that offers 0% interest for a promotional period – usually about a year. The rub, though, is that you’ll need to be able to erase your debt before the promotional period expires — and the rate jumps back up.
- Debt consolidation loan. You can use the cash from a debt consolidation loan to wipe out your debt then repay the loan in monthly installments. The strategy also streamlines bill paying, since there’s only one, fixed monthly payment to deal with, as opposed to multiple payments of varying amounts and due dates. You can get a loan if your credit score is 689 or below, but those with the highest scores get the best rates.
When Is Debt Consolidation a Smart Move?
For debt consolidation to work, experts say all the following should be true:
- Your overall debt – minus your mortgage – is not more than 40% of your gross earnings.
- You have the credit to qualify for a 0% balance transfer card or low-interest debt consolidation loan.
- You consistently make your debt payments, with no cash flow issues.
- Your spending is under control.
Here’s a situation, for example, in which consolidation’s a good fit: You have five credit cards with interest rates between 18.99% and 24.99%. Your credit’s good because you’ve been making timely payments, so you might be able to snag a loan with a 7% interest rate – markedly lower than what you were paying.
When You Should Pass on Debt Consolidation
Debt consolidation is not a panacea for debt woes. For one thing, it doesn’t fix the root (overspending?) cause of whatever got you in trouble in the first place. It’s also not ideal if you’re overrun with debt and know you can’t erase it even with slashed payments.
Also, if you can clear your balances within a year just by doing what you’re doing – and you won’t save much by consolidating — take a pass. Instead, you may want to consider employing another method, like debt avalanche or debt snowball.
- Debt avalanche. This strategy involves paying off debt starting with the loan with the highest interest rate. You then pay off the card with the next-highest rate and repeat the process until all your balances are gone.
- Debt Snowball. With this method, you pay off your smallest debt first, while making minimum payments on the others. After you pay that one off, move on to your next smallest, and keep repeating the process.
If debt consolidation isn’t your best bet, you might want to go the debt relief route rather than wasting time and money and not making progress.
So, is it smart to get a debt consolidation loan? You have your answers above. The fact is that the strategy has helped scores of consumers. See if it’s the right move for you.