Debt consolidation is an appropriate action to take when you are overwhelmed with debt from more than one source. For example, if you are struggling to handle your student loan debt on top of a credit card payment, and you are only able to make the minimum payments on these loans, you might want to consider consolidating your debt.
It is, unfortunately, not uncommon to find yourself mired in debt and unable to see the light at the end of the tunnel. High annual percentage rates (APRs), adjustable rate loans, late payments or balance transfer fees can all make huge differences in the amount of cash you’ll end up paying out by the end of your loan. Not to mention the charges your loan might incur if it is transferred to a different financial institution within the term.
The main benefit of debt consolidation generally lies in retaining the funds you’d normally waste paying interest and putting them toward the principal payment instead. Take, for example, your basic credit card interest payment. Generally, this payment is based on a compound interest rate based upon an amount that you spend, which we will call your principal sum. You will pay an interest rate on that sum, (for credit cards this is normally between 12% and 18%). In addition to paying that interest rate on your principal sum, you will also pay interest on the accrued interest that you have built up while trying to pay down your original sum! So essentially you are paying interest on your interest. It is easy to see why so many customers who have agreed to loans with compound interest rates feel hopeless about ever ending their debt.
When faced with these challenges, debt consolidation can be an excellent solution. There are several different ways to consolidate your loans. You might consider taking out an unsecured personal loan within a bank to pay off your high-interest debt. The interest rate will usually be at least half that of a standard loan. In addition, these loans are usually simple interest loans. What this means is that you pay interest on only the original sum of your loan. No more paying interest on the interest you’ve already paid in. Much more of your payment will go toward the principal sum of your loan.
If you are a homeowner, you may have an option to have a home equity loan attached to your mortgage. The good news about these loans is that your biggest asset (your home) is doing much of the work for you in qualifying you for a low interest rate. The bad news is that many of these loans are ARMs (adjustable rate mortgages). These can be risky because you do not have a fixed interest rate that will be guaranteed for the term of your loan.
Just as taking out any loan is a risk, taking the risk to consolidate and change the terms of your loans can be unpredictable. Always do your research and consult with a qualified financial professional before consolidating a loan, and never give access to your finances to any representative that promises a quick fix.