5/19/2023
You've heard it before, but you're not clear on how to consolidate debts. Here we are to clear up some of your doubts and give you our best guidance to face this process, which can allow you to save a lot of money and pay off your loans and credit cards faster and more comfortably.
What is debt consolidation?
Debt consolidation is a very useful financial strategy when you have accumulated several commitments with creditors.
If you've gotten into debt from credit cards, various personal loans and other financing, you can put it all together through a loan or management plan to simplify your payments into one.
By consolidating debts, you can lower your interest rate and monthly payments. It's a convenient way to manage your outstanding bills.
This way, you only have a single date assigned to make the payment for what you owe. Of course, this option is not always the best solution.
Common requirements for consolidating debts
The fundamental criterion for you to be able to consolidate debts is to have a stable source of income. This should be accompanied by a good credit standing, which translates into a FICO score of 740+.
When you are between 739 and 670, you may qualify, but the APR may not be the best. If you're below 670, you'll have a harder time finding a worthwhile option.
When should you opt for debt consolidation?
Although consolidating debts sounds like an ideal solution, each case merits an accurate assessment. We usually advise it in the following scenarios:
- A large debt. When you can pay off what you owe in 1 year or less, then consolidating debts does not make much financial sense.
- You have a score to obtain a good APR. To the extent that your score has grown by opening accounts, you have better credentials to get an interest rate that allows you to save for the long term.
- You have enough money for your fixed expenses. It will always be ideal if you can afford your regular commitments plus the new monthly consolidation fee. Even if that payment goes down, not being able to afford it makes it a bad plan.
- You plan to correct your financial habits. Any good debt management plan should be backed by corrective measures to avoid past mistakes. Before evaluating a consolidation, try to self-examine your finances with a view to improving your financial management.
Advantages of consolidating debts
You already know that consolidating debts allows you to better organize your debt repayment. However, there are other benefits associated with this process:
You reduce your monthly payments.
Since debt consolidation includes financing with a lower rate and a longer term, this translates into smaller installments for the duration of the credit. However, the longer you take to pay, the more money you put down.
You can pay faster
When you apply for a loan to consolidate debts and its interest rate is lower than each individual debt, it is a good idea to pay a little more with the money you save.
If you manage to pay off such financing early, you also pay less interest in the end. Generally, this kind of credit extends the term, so you have to commit to pay it off sooner.
It allows you to increase your FICO score
Although applying for a new personal loan initially takes away a few points for the hard inquiry, you can compensate in several ways.
One is by paying down revolving credit on credit cards or lines of credit, which reduces the utilization rate (ideally below 30%) on your report. In addition, when you pay any commitments on time and consistently, you earn points on your reputation.
You may be able to improve your interest rate
If your credit score has improved with the commitments you've made, consolidating debts can help you get a lower overall interest rate.
Even if you don't choose a long-term loan, you can still save money with this option. The recommendation is to shop around and look for lenders that provide pre-qualification. Remember to evaluate the interest rate based on how much each of your debts add up to.
Ways to consolidate debts
Usually, it is recommended to consolidate debts with higher interest rates, such as credit cards and some quick loans. There are several ways to do this:
- Interest-free credit card at the beginning (0% APR). With terms ranging from 6-22 months and a 3%-5% balance transfer fee, this is a good option. You need a score of 690+ and calculate if you can pay within the grace period.
- Mortgage loan or HELOC: If you have a home, this revolving financing has a low rate and an extended term. You don't need to show a good score, but you do need to have equity in the property and risk losing the collateral.
- 401(k) loan. When your employer offers you this alternative, you get a low APR and up to 5 years to repay. Among its details, you reduce your pension, there are costly penalties if you can't repay and the term is reduced to 1 year if you become unemployed.
Español: ¿Cómo consolidar deudas para pagar menos?