Is Debt Consolidation Right For You?

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You and a friend are out to lunch and they can’t stop bragging about how life is so much better now that they’re finally debt-free. You ask how they managed to pay off all their debt in a short time and they respond: “It’s easy – just consolidate your debt.”

What? It’s that simple? Just consolidate the debt? Okay, so now you’re ready to consolidate all your debt. The student loans, credit cards and car loan– CONSOLIDATE THEM ALL!

But, wait. What does debt consolidation even mean? Just because this worked for your friend, it doesn’t mean it’s gonna work for you too.

Let’s start from the beginning. 

  • Who: You! 
  • What: Combining all your debt into one giant account, also known as debt consolidation
  • Where: Online or in-person with a debt consolidation loan
  • When: Anytime you want
  • Why: Because you’ll only have one account instead of multiple, and that comes with one due date, one monthly payment and one lender

Now, let’s talk about the “how!” We’ll tackle this in two parts: 1) How do I know if debt consolidation is right for me?  2) How do I find a good debt consolidation loan?

How do I know if debt consolidation is right for me?

Ask yourself the following questions. If you answered “Yes” to every one of them, then you’re probably a good candidate for debt consolidation. 

  • Is the total amount of debt I owe (not including a home mortgage) less than half of my income before taxes?

Unless your income is incredibly high, it can be difficult to live off of less than 50% of your income. This is why it’s so important to make sure that your debt-to-income ratio is not too high.

  • Is my credit score in the fair credit range or better? Can I afford to pay the minimum balance due for each of my debts each month? 

As a rule of thumb, 40% of your gross income should be more than or equal to your total debt. This, coupled with your credit score, will allow you to be approved for a debt consolidation loan. If your income is too low compared to your debt, then you either need a higher paying job or another job to boost your income on paper, regardless of your credit score.

The credit score is important because it allows you to get approved for debt consolidation. The better your score, the lower your interest rate will be on the new loan, which you’ll use to pay off all the debt you have. Having one low interest rate and one monthly payment makes your financial situation a lot more organized and simplified. These are factors that indicate a higher likelihood of paying off debt successfully.

  • Do I have a plan to prevent myself from getting into debt again after consolidating?

This is probably the most important (and toughest) part because debt consolidation only works if you don’t go running up debt again. In 2013, I consolidated credit card debt of almost $20,000. I knew it was the right move for me because I had four different credit cards. Each of them ranged from a 17% interest rate up to almost 25% in interest! I always paid the minimum balance, which meant that my credit was in good standing. After applying for a debt consolidation loan, I was approved for a 9% fixed interest rate loan for a term of 5 years. I ended up paying it off in much less time by being more aggressive with my monthly payments.

For me, debt consolidation was the light at the end of the tunnel, which I just could not see before with all of my different debt amounts and due dates that stressed me out. If I had continued to make my minimum payments on those credit cards, it would’ve taken me over 15 years to pay back all my debt.

How do I find a good debt consolidation loan?

There are actually two common ways that people consolidate debt.

The first way is described above through my own example. In this case, you need to spend some time online comparing debt consolidation companies or loans. Tons of popular blogs will post something along the lines of “The top debt consolidation loans of 2020.” Your job is to do your research by reading these blog posts and look for the trending names and companies. If something peaks your interest, call them up or visit their website to learn more and see if you pre-qualify. By entering some basic information, you can usually determine a range of interest rates that you qualify for and how much you can expect to get approved for. Finding out if you pre-qualify should NOT impact your credit score at all. Be sure to confirm that by asking if this pre-application affects your credit score in any way. 

The other method is to get a zero-interest promotion for balance transfers on a credit card. This allows you to use that credit card to pay off all the debt you owe. Then, you’ll be able to transfer it onto the credit card as a balance due. You’ll then need to make sure that you pay off that credit card in full before the end of the promotional period. To do this, count the weeks or months left in the promotional period and divide that by your total debt. This way, you’ll know how much you should be setting aside for your weekly or monthly payments.

Consider Additional Fees

Regardless of which method you choose, you definitely want to make sure that you are not worse off financially because of that choice. Find out what the fees associated with your debt consolidation option are.

For loans, this means looking for pesky origination fees or deposit fees. Try negotiating them down or avoiding them altogether. With the zero interest credit card option, you’ll want to calculate the balance transfer fee. This fee is usually a percentage of the amount of money you transfer over onto the card. For example, say you use the card to pay off a car loan of $5,000 and a personal loan for $7,000. You’ll now have a balance transfer of $12,000 total. If the balance transfer fee if 3%, that makes it an additional $360 in fees, making the total amount you owe $12,360. If this amount is less than what you would pay with two different lenders, then move forward and pat yourself on the back for saving your coin! 

Now that you know exactly what debt consolidation is, let’s wrap up with what debt consolidation isn’t. Debt consolidation is not a blank slate from your debt problems. It doesn’t do anything to change your spending habits or money mindset, which could very well likely be the reason why you became debt-ridden in the first place. If you find yourself overwhelmed by debt-related problems, then you might want to schedule an appointment with a debt relief organization so you can talk to a professional about your situation.