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Life is sure to become stressful when you have a heavy debt load.
Prior to a consolidation loan managing payments and dealing with creditors is difficult when you can barely keep your head above water and struggle to make ends meet. Consumers can get into a vicious cycle of running cash deficits and continuing to use credit cards just to survive. As they approach the brink of insolvency, they begin to look for solutions that will keep them afloat.
Much of the debt they have is credit card debt. At the end of the fourth quarter of 2022, Americans reached a historical high in its debt levels consumer debt. According to the Federal Reserve Bank's Household Debt and Credit Report, household debt reached a whopping 1Q4FY16.90 trillion and credit card balances stood at 1Q4FY960 billion, which surpassed the pre-pandemic record of 1Q4FY927 billion.
With household debt reaching new heights, many people are considering debt consolidation loans as a means of managing their overwhelming debt. While this type of debt relief can be a viable means of managing your finances, there are important advantages and disadvantages to consider and questions to ask yourself before going down this path.
Before we cover those questions, let's delve into how debt consolidation loans can take the weight off your shoulders and your finances.
What is a Debt Consolidation Loan?
A debt consolidation loan combines your unsecured debts into a new loan with a single payment. You use the proceeds to resolve all of your current qualifying credit card debt, which puts an end to late payments and fees. You may be able to save money by paying less interest on the new loan.
This would likely mean that the new payment could be less than what you were previously responsible for. Also, making only one payment per month instead of many streamlines the process. This can reduce stress by reducing the chance that you will miss one payment while juggling many.
Reducing your cash outflow can give you the opportunity to control your debt problem or invest more money to solve it. Debt consolidation loans come in various forms and it is important to choose the right one for your financial situation.
Many homeowners seek to use the equity in their homes to address their debt problem. This is only possible, of course, if you owe much less on the mortgage than the home is worth. Many times, this equity comes from a home equity line of credit or HELOC.
If you receive approval for a line of credit, you can generally use the funds in any way you wish, including as an effective way to consolidate your debt. HELOCs generally require that you have a large amount of equity in your home and the ability to show a verifiable source of income.
Using Capital
You can also choose to use the equity in your home by refinancing your mortgage and using the additional cash to pay off your debts. Another option is to borrow more money than the current balance on your home mortgage and use the excess to consolidate credit card debt into the mortgage.
As with a HELOC, you would need adequate equity and verifiable income to qualify for a home refinance.
If you have relatively low credit card balances, a personal loan may be a viable option. Banks and finance companies generally make these loans to borrowers who are in good financial standing and do not have a large amount of debt.
Interest rates on personal loans are usually lower than those charged by credit card companies. But the loan term is often short, compared to mortgage loans. Many borrowers apply for these loans to pay off their credit card debt quickly.
Advantages Of Debt Consolidation Loans
Debt consolidation loans can help you get your financial problems under control. Here are some of the advantages of debt consolidation:
Single Payment
For many people, one of the most attractive aspects of getting a debt consolidation loan is combining all of their debt payments into one payment. Having only one payment to make each month can help you stay organized and avoid missed or late payments.
Reduced Payments
Most consumers consolidate their credit card debt to reduce the amount of money they pay each month. If you can get a lower interest rate, you could see substantially lower payments, depending on the length of the terms. This could help you save money for emergencies or pay more on your debt each month.
Lowest Interest Rates
Debt consolidation loans, such as mortgage refinancing, HELOCs and personal loans, will almost always have a lower interest rate than credit cards. As a result, you may be able to make lower payments that can help you make ends meet and stop living paycheck to paycheck.
By saving enough money each month, you may be able to build an emergency fund and enjoy some financial security for you and your family. This is a recommended protective measure that can ensure funds are available when you face financial emergencies, such as expensive medical bills, costly car repairs or even job loss.
Getting Stuck
If you've fallen behind on payments or are struggling to keep up, a debt consolidation loan can be a breath of fresh air. With your credit card bills resolved and debts consolidated into one monthly payment, you can stop worrying about missed or late payments. Instead, you can focus on what matters most: getting your financial life back on track.
Disadvantages Of A Consolidation Loan
The loans of debt consolidation carry some significant advantages for consumers who use them to address a burdensome debt problem. However, there are some potential drawbacks to be aware of when considering a consolidation loan.
Three questions to ask before obtaining a debt consolidation loan
Three Questions You Should Ask Yourself Before Getting A Debt Consolidation Loan...
1. Have I made the lifestyle changes necessary to make debt consolidation successful for me?
It is important to recognize the circumstances that led you into debt in the first place. If you have been overspending or spending irresponsibly, this will have to change. If you continue to live beyond your means and start relying on credit cards to make ends meet, you will soon find yourself back at square one.
If your problem arises from circumstances beyond your control, such as an unexpected illness or injury or the loss of a job, make sure that your situation has improved and that you will be able to meet your obligations in the future. A debt consolidation loan can only make your financial situation worse if you continue to accumulate debt as you pay off your new loan.
2. Have I chosen the right type of loan for my circumstances?
As mentioned above, there are several types of debt consolidation loans. It is important to remember that bundling your debts into your home mortgage has some risk.
If you can't make your largest mortgage payment, you could be putting your most valuable asset at risk. Losing your home to foreclosure is a monumental and catastrophic event, so make sure you're not inviting that risk with a new debt consolidation loan.
If your debts are not too large and you are looking to resolve them quickly and efficiently, you may want to consider a personal loan. Personal loans can be a good option for those with relatively small credit card balances.
3. Are there other options available besides a debt consolidation loan?
Debt consolidation can be a good option for many people, but qualifying for a loan can present considerable challenges if you have had financial problems for quite some time.
If you are willing to work hard and be diligent about resolving your credit card debt, you may be able to handle things on your own.
