What does consolidating debt mean and how do debt consolidation loans work?
It can happen seemingly overnight. No matter how hard you tried to manage your spending, you’re suddenly faced with credit card debt you can’t pay. You try to pay your cards down, but that taps into the money you’d usually use for groceries and you find yourself using your card, again, to make those purchases. The stress your credit card bills cause is impacting your entire life, and you’re not sure how to make it stop.
What is Debt Consolidation?
If you’ve researched online, you have likely seen advertisements for debt consolidation loans. These can be incredibly powerful tools in helping you to end the cycle of debt but it’s important to understand how they work before you apply. Essentially, a debt consolidation loan is a loan that pays off your existing debts. The proceeds you receive from the debt consolidation loan will be used for this, and then you make a single monthly payment on that loan.
A Nation in Debt
Data sourced from the Center for Microeconomic Data’s Q3 2018 Household Debt and Credit Report.
Aggregate household debt balances increased in the third quarter of 2018 for the 17th consecutive quarter. As of September 30, 2018, total household indebtedness was $13.51 trillion, higher than the previous peak set in 2008.
Low Rates, Single Payment
There are two main reasons why a debt consolidation loan can help you regain control of your finances.
- Low rates. Debt consolidation loans typically have a lower interest rate than most credit cards. This is important because the lower the interest rate, the less money you are spending on interest charges and the more money you can be saving. More of your monthly payment is actually going towards the balance. When you make minimum payments on your credit cards, you’ll notice that your balance goes down the smallest amount and there’s no certainty as to when your card will be paid off. With a debt consolidation loan, though, you’ll have the ability to know exactly how much of your payment is going towards your balance as well as a defined pay-off date.
- Single payment. If you are consolidating several credit cards or other debts, you are eliminating the hassle of having to spread your money across several bills and, let’s face it, remembering to pay them all. With a debt consolidation loan, the funds you receive from the loan pay off all of those other balances, leaving you with a single payment each month.
Can a Home Equity Loan or a Home Equity Line of Credit (HELOC) be used for debt consolidation?
Both a Home Equity Loan and a Home Equity Line of Credit (HELOC) are potential solutions for debt consolidation. Both options are secured by your home’s equity, meaning your interest rate will likely be lower than with a personal loan, which is a form of unsecured credit. Because the goal of debt consolidation is to help you pay off the amounts owed and start saving money, you will want to find the option with the best possible interest rate.
Determining which is a better option, though, depends on your individual needs. There are pros and cons to both so it’s important to be honest about your financial picture before deciding which option is best for you. If you need a lump sum to pay off debt, and won’t want to use that money again, then a Home Equity Loan may be the best solution for you. Since it is a loan, you will get all of the funds upfront. This money would go to paying off your other debts, so that you only have a single payment on your Home Equity Loan each month. One key advantage to this option is that you will have a fixed interest rate, meaning your monthly payment will stay the same, provided you don’t accrue any late fees. This is crucial for budgeting.
You’re Not Alone
A recent survey by US News & World Report& of people who had taken out debt consolidation loans revealed the following:
Of the respondents, more than half were consolidating credit card debt.
The biggest issues the respondents were facing included accumulating interest charges, budgeting for debt payments, and keeping track of multiple accounts.
On the other hand, a HELOC can provide you with a line of credit from which you can draw the amount needed to pay off your debt, and still potentially leave you with funds to draw on in the future. With a HELOC, you will likely have a variable interest rate which can make it harder to budget for the payments. During the draw period (or the amount of time during which you are allowed to use the line), your payments will likely be interest-only, which could save you some money. Once your draw period is over, though, you will enter the repayment period and will need to begin paying off your HELOC. The advantage to this option is having access to the line of credit in the event of emergencies, although it’s important to be disciplined enough to access your HELOC only if you really need the funds.
Estimate your monthly payment with our Home Equity Calculator.
It’s important to note that you are not accumulating more debt by pursuing a debt consolidation loan. Rather, you are erasing your other debts by paying them off with the proceeds from your loan.
What do I do after consolidating my debt?
If you pursue a Home Equity Loan or HELOC for debt consolidation, remember that consolidating your debt won’t work if you don’t take steps to manage your finances responsibly afterwards. Avoid piling the credit card debt on again. Practice reaching for cash instead of your card. If you can’t pay off your credit card within a month or two, don’t make the purchase. Falling back into the habit of using your credit card will leave you in a worse financial situation, as you will have new credit card debt plus your Home Equity Loan or HELOC payment. One of the most effective things you can do to manage your finances is to create and maintain a budget. Using a budget will help you pinpoint where you might be overspending, and how you can adjust your spending to not only stop accruing debt but start building your savings.
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Don’t wait to consolidate your debt
Don’t wait until your payments are late to consider debt consolidation. Keep in mind that late payments will impact your credit score, and your credit score is a huge component in determining your eligibility for debt consolidation loans. Financial institutions help thousands of people each year manage their debt, so there is no reason to hesitate to ask for help in managing yours. It helps to have copies of your credit card statements and other debts with you when you speak to a representative. This will allow them to see your balances and interest rates and explore your options with you.
Applying is easy, fast and can be done online
If you’re ready to consolidate your debt, you can apply right from your phone, tablet or desktop.
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