People trying to consolidate their debts have one burning question: “Is it a good idea to take on more debt to pay off your existing debts?” This article will give you a quick overview of debt consolidation loan, how it works and whether or not it is good for your financial situation.
What is debt consolidation?
With debt consolidation, you take a new low-interest loan to pay off all your existing high-interest loans or debts. The goal is to lower the interest, save money and pay your debt faster while cutting down on multiple monthly installments to just a single payment.
Is debt consolidation good or bad?
It depends! A better question to ask would be “Is debt consolidation effective?”
If you are disciplined about making payments, it is effective. But many people don’t have a plan to get out of debt even after consolidating it. So, for those people who make poor choices as far as finances are concerned, debt consolidation is ineffective.
Most Common Methods of Debt Consolidation
The most common debt consolidation methods are as follows:
A 0% interest, balance-transfer credit card: If you have a good credit score and credit history, you can get a low-interest credit card to transfer the high-interest balances. By transferring your balances onto a single card, you save a lot on interest payments.
A personal loan balance transfer: It’s a viable option when you have multiple high-interest debts. Make sure you do a comparative analysis of the different personal loan offers from different banks and lenders to find the right personal loan with the best interest rates.
Debt consolidation is a good idea when:
- Your total debt is not more than 40% of your gross income.
- You have a good credit score to qualify for a 0% credit card or low-interest debt consolidation loan or personal loan.
- You have a consistent cash flow that can cover your monthly payment.
- You have a solid plan to prevent yourself from getting into debt again.
Debt consolidation is a bad idea when:
- Your debt is so huge and there is no hope of repaying the debt even after debt consolidation.
- Your debt is small that you can pay it off within 6 months to 1 year at your current pace.
- You have no control over your spending, and you are bad at making payments on time.
- Your total debts exceed half of your income, debt consolidation may not be the best option. Instead, seeking debt relief could be a good idea.
After Debt Consolidation – What’s Next
How to Avoid Racking up More Debt After Debt Consolidation
Debt consolidation is not a silver bullet to stop all debts. It may help you reduce your debts, but if you want to be debt-free, you need to make significant lifestyle changes to ensure you don’t pile up debt.
Before applying for a debt consolidation loan, make a solid plan to repay the debt consolidation loan. These tips can be helpful:
- Identify the root problem — Review your statements to see where you overspend and make necessary amendments.
- Create a budget — Come up with a realistic budget and stick to it. Take a hard look at your spending habits. Set limits and avoid carrying balances from month to month.
- Stay focused — Repaying your loan has to be on top of your mind.