Debt consolidation is when you decide to merge all your open lines of credit and pay them off by making just one payment. The main idea is to bring down your interest rate. Consider a scenario where you have card payments due and upcoming loan instalments that need to be paid. But no matter how you see it, you are unable to bridge the gap between what you owe each month and your income. If this is true for you, you might want to consider debt consolidation.
It is easy to give into the appeal of consolidating your debt. Whether consolidation is a smart choice for you will depend on your financial situation. Let us consider different cases and the pros and cons of each debt consolidation plan.
Only Credit Card Debt
Do you hold multiple cards and are struggling to pay the minimum amount due per month? If your debt is confined to just credit cards, then you can consider the following repayment solutions.
Balance transfer is a facility where you transfer the outstanding amount of other cards onto one card. The goal is to choose a card that offers zero or very low interest rate, and repay the debt within the time period specified by the bank.
What Works in Your Favour?
- Repay your debt with a card that offers lower interest rates.
- You can save on the interest that you would have to pay on each of the cards. The money you save can be used to pay off the consolidated outstanding amount.
- You won’t have to keep track of all the different due dates and risk making late payments.
What do You Need to Consider?
- Balance transfer will require you to pay a higher minimum amount each month in order to repay the amount you owe. This could put a serious dent in your finances, especially if you are already struggling to make the minimum amount.
- In order to enjoy the low interest rate, the amount that you transfer from other cards must be paid off within the promotional period. Failing to do so will incur standing finance charges, usually between 15% to 18% p.a.
If the idea of balance transfer does not appeal to you, you can opt for a secured loan. Secured debt consolidation is based on taking a loan to pay off your debt against some sort of collateral. You can apply for loan by submitting car, property, and stocks.
What Works for You?
- You can use your collateral to get the loan at a lower rate of interest.
What do You Need to Consider?
- As a general rule, moving unsecured debt to secured debt is considered as bad practice.
- You will be at the risk of losing the asset if you fail to pay the instalments.
A Mix of Card Debt and Loans
Do you hold 2 or 3 credit cards to your name, and have taken a home loan as well as car loan? In such a scenario, you could consider an unsecured debt consolidation loan.
Taking a Personal Loan
Personal loans can be used for any purpose, even debt repayment. Personal loans that are used to pay off debt are called debt consolidation loans. The loan amount will be equivalent to the total debt you owe.
What Works for You?
- Generally, personal loans are available at a lower interest rate than credit cards. You could end up saving on the finance charges and use that to get out of debt.
- This is an excellent option if there is a chance that your finances or spending habits are going to change in the near future.
What Do You Need to Consider?
- Your monthly instalment could cut into your cash flow and may force you to start using your credit card to pay for essential purchases.
- By taking a personal loan, you are opening up a new line of credit. This may not be a good idea if you are struggling with debt.
What is the Impact of Debt Consolidation on Your Credit Score?
The next thing for you to consider is the impact of consolidating your debt will have on your credit rating. Depending on your attitude towards repayment, your score could either go up or down. You will see your score improve by making timely payments month after month and streamline your purchases to just the essentials.
If you want to opt for balance transfer, but don’t have a card that offers this feature, then you will have to apply for a new one. This could bring down your score because you will be reducing the overall age of your credit account.
Applying for a new line of credit also affects your score negatively. When you seek a new card or loan, an enquiry is made into your score to check for eligibility. Each enquiry brings down your score. This holds true for both, balance transfer and debt consolidation loans.
While considering your options to consolidate your debt, the first thing you need to do is compare the rate of interest and tenure of the consolidation loan to all your credit lines individually. If the interest is lower, then combining your debt into one is a good idea.
Take the help of comparison websites to get a better understanding of the loans and balance transfer cards offered by banks. Understand the requirements, fees and charges involved, and other conditions before proceeding. In addition to consolidation loans, you can consider other repayment options like debt settlement, debt management, or debt counselling.