Typically debt consolidation for most of us is understood to be a loan. Often, people might consider using a balance transfer, as a form of debt consolidation as well.
What types of loan, exactly? Well, loans you might get from your bank, a personal loan, or a peer to peer loan, or maybe a home equity line of credit.
And when you’re taking out a loan for consolidation, you’re typically going to be paying off multiple accounts. This is the kind of consolidation we are talking about here.
Pros Of Debt Consolidation:
Okay, first off, the main purpose of consolidating your debt is to lower your interest rates.
So let’s assume, for a moment,you have five credit cards and the average interest rate is 17% and you can get a home equity loan and pay 6%. The benefit there is obvious.
In the case of a balance transfer, some of those interest rates could be fantastic, right? You can get intro rates that are 0% or relatively low, lower than 5%.
And if the balance that you have available to use and transfer other debts onto that is large enough, you might be able to whack out allof your other unsecured debt, say those five credit cards again. So that’s a very real benefit as well.
Another pro is simplification. And it’s because you only have one payment now.
If you’re consolidating five credit cards into one loan, just paying them all off and now you just have the one loan and only one payment to make.
It’s less to keep track of, it’s less things to worry about, ACH payments from your bank account or keeping track of things. In other words, the simplicity is a benefit.
Yet another pro and it will depend on who you are and how stretched your finances are, but the preservation of your credit, of your credit score, or having nothing happen to any of the trade lines on your credit is a huge benefit to consolidation and let me explain.
When you do alternatives to debt consolidation to manage, if you’re in a tight spot and you absolutely are doing this to get the lower interest rates, otherwise how are you going to afford your bills.
The alternatives like bankruptcy and debt settlement hurts your credit. Even with debt consolidation through counseling, a different type of debt consolidation, through a credit counseling agency and non-profit, they actually close your accounts.
In regard to credit score, it doesn’t really hurt your score doing credit counseling exactly. But it’s on your report that you’re on a managed plan, and it can prevent other options,other financing options, at least for a little while when you’re on one of those plans.
So, debt consolidation loan is probably the best way to manage that debt situation and get a better interest rate and have it preserve your credit.
Remember one benefit is a fixed payoff. Now, assume for a moment that you’re doing this correctly and you are taking those five credit cards for example and you are combining them into one payment.
And now, that fixed loan is not something that revolves, where you can use the credit card a month to pay some and then use it some more the next month and then pay it off and the balance fluctuates andthe minimum payment fluctuates.
In a traditional consolidation loan, it’s gonna be a fixed payment and that gives you a fixed time to pay it off. So there’s a great deal of benefit in that, in predictability.
Balance transfers can also be considered a pro in that there’s a lot more flexibility in balance transfers because banks do compete for your business.
Once you’ve done a couple of these consolidation types of events through balance transfers though, it starts to look like you’re playing musical chairs. So, it can also be a con.
But at least in this context where you have more options, banks competing for your business, those balance transfers could be seen asa pro, depending on who you are.
Cons Of Debt Consolidation:
On the con side, one of the biggest problems is you do the balance transfers or the consolidation loan and you don’t close those other accounts and I get it, but you start using those other cards.
They were paid down to zero and suddenly now you’ve got those racked up, those charges, and the minimum payments that are now again, stretching your budget thin.
And you don’t have that flexibility anymore in your budget, because you have one consolidation loan that you’re paying the minimum payment one very month and now you’ve got the credit card bills on top of it, so it’s compounded.
Your earlier efforts to consolidate your bills, needing to do it again and not have a lot of options. So be very careful about that.
Balance transfers are usually at an introduction rate. So it’s not like you get this consolidation balance transfer loan type of product, and it stays at that low, low teaser interest rate, for the lifetime of the balance. Usually, it’s like a year.
So, you transfer all your balances over there, and everything’s affordable because it was an intro rate. It was 0%, it was 4%, now 9%, and then in the 13th month, it goes up to 11% or 8% or something like that. And suddenly now that’s not within your budget.
Or you missed a payment accidentally and now the intro rate is gone. So these balance transfer changes or these introductory rates are only temporary.
The person who has a consistent income, very fixed and is able to do and afford their bills, doing a balance transfer and then at their end-of-year bonus that they know they get every year or they get their tax refund and they pay that stuff down.
That’s okay. But if your income is not consistent, if your spending is not consistent, if you have unexpected expenses come up and you start using those cards again, those balance transfers are usually a stop gap type of measure at a critical point where you change your behavior as well.
Another con for consolidation loans and balance transfers is you have to apply for these things, these other accounts. And you have to get approved.
So if you’re already stretched to a place where your interest rates aren’t affordable, it could very well mean that your debt to income ratio, your credit utilization on some of your accounts that you’re trying to consolidate, are so high that you won’t qualify.
So that’s an impediment to being able to consolidate in the first place, so be careful!