Debt Consolidation: A Guide to Understanding the Essentials
American household debt reached a shocking $13.21 trillion in 2018. People under the age of 35 carry $67,400 in debt on average, while debts tend to peak at $134,600 between the ages of 45 and 54. Debt has continued to rise regularly year after year.
In its Quarterly Report on Household Debt and Credit, the Center for Microeconomic Data revealed that Americans saw a rise of $198 billion in household debt, or 1.4%, during the last quarter of the year in 2019. Mortgage originations went up by $224 billion, or 42%, in 2019, taking this debt ratio to the highest it’s been since the fourth quarter of 2005. Debts for education also make an impact. The fourth quarter of 2019 saw at least $10 billion in student loans.
Looking at those numbers, it’s easy to see how you could quickly get in over your head with debt and have trouble paying your bills, especially if you lose a job, get hurt or have to deal with other unexpected circumstances. One thing that can help is to use debt consolidation methods to reduce your payments and interest rates. Consolidation isn’t right for everyone, but it can be a good way to get back to making payments on time and having money left over to live more comfortably each month.
This article covers everything you need to know to help you decide if debt consolidation is right for you.
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What Is Debt Consolidation?
Debt consolidation is a way to streamline your debts by placing them all onto a single personal consolidation loan. This can help you reduce the interest that you pay each month and may lower the overall monthly payments you make for your debts. With debt consolidation, the goal is to put all of your debt onto one loan, so you only make a single payment each month. You can make that single payment yourself or work with a credit counseling agency.
How Does Debt Consolidation Work?
With debt consolidation, the goal is to take out a personal loan that covers all the debts you want to combine. You file for that personal loan with a lender, such as your bank, and then take the money you receive to pay off your creditors. Now, instead of making monthly payments to multiple lenders, you make a single payment on your debt consolidation loan. This helps keep your finances more organized and makes you less likely to default on payments, as you no longer need to remember multiple due dates or payment portal logins.
There's another option as well, which is to use a home equity loan or home equity line of credit to get the financial support you need to pay off your debts. With these options, you contact your mortgage lender to borrow against your home. It's vital to remember that you're borrowing against your home with your home as collateral, so if you don't make payments, you could lose your home. Not all loans are like this, which is why it's good to look into multiple options.
Lendzi can offer guidance on how the process works based on the kind of loan you want, such as funding for student loan debt consolidation or credit card debt consolidation. We're happy to review the best debt consolidation loans with you so you can make an informed decision.
Should You Consider Debt Consolidation? How Much Debt Is Enough?
It's smart to consider debt consolidation in a few cases. You might want to use a consolidation loan if:
- You have high interest rates that would be lower with a new loan
- You have home equity that could be used for a low or no-interest loan
- You have a high debt-to-income ratio that makes it hard to live normally due to the debt you currently have
The amount of debt that's enough for a consolidation loan might vary by person. If you can get a 0% interest credit card or low-interest debt consolidation loan, then almost any amount would be worth it because you'll save so much in interest over the course of your loan. Debt consolidation rates vary based on your credit score and other factors, such as payment history and credit utilization ratio.
Is Debt Consolidation Always a Good Idea?
Loan consolidation isn't always a good idea. There are three times when you may want to consider other options, such as using the snowball method or seeking debt relief through bankruptcy. Here are some instances where using debt consolidation doesn't make sense.
- 1. It's usually a bad option for people who are likely to take out the new loan and waste it instead of paying off lenders, getting into more debt. However, if you do take the money you receive and pay off your debts, then that could make debt consolidation right for you.
- 2. If your debt load is small, consolidation may not make sense for you. If you can pay off what you owe in six to 12 months, then you're only going to save a small amount if you consolidate. It may not be worth it.
- 3. If your debts exceed half of your income and you have trouble finding a 0% or low-interest loan, then debt consolidation may not help your situation, and there could be better options available.
When Is Consolidation Right for You?
While there are times when debt consolidation is not right for you, like when you don't have an income or when you won't get a good rate, there are also some signs you can look for that would let you know that debt consolidation is a good option. Consider these points before you consolidate your debts:
- If your debt exceeds 40% of your gross income, it's likely time to look into consolidation.
- If you can make regular payments and have a consistent income, then debt consolidation may be a good choice.
- If you have a budget and plan in place to avoid getting into debt again, consolidation can work.
- If you have good credit and can qualify for a 0% credit card or low-interest debt-consolidation loan, then that's a potential option for you.
You may have a mix of benefits and disadvantages when you consider your personal situation. If that's the case, contact the knowledgeable team at Lendzi for guidance.
How Do You Know If a Lender Offers Consolidation Loans?
Many lenders do offer debt consolidation. When you look at their website, they should have a number of different personal loans listed. Some may be for buying cars or a home. You'll want to choose a personal loan that's designed for debt consolidation or that covers the total value of your debts, so you can pay off your individual lenders.
Some typical vendors who offer consolidation and personal loans include banks, credit unions and major credit card companies, such as Capital One and Discover. We can help you review the pros and cons of debt consolidation and also explore programs near you.
Will Debt Consolidation Affect Your Credit Score?
Debt consolidation has the potential to help or hurt your credit score. For example, it can hurt your score if the consolidation results in you closing down your lines of credit. When you close a line of credit, you change the credit utilization ratio. If you just take out a new loan on top of the credit lines you already have, your utilization rate will go down. If you close the lines of credit and open the new loan, the utilization rate will go up, since you have less available credit.
Your payment history is another vital aspect of your credit score and makes up 35% of your FICO score. It's essential that you or the credit counseling agency you work with make payments on time. If you or the agency don't make payments on time, you'll see a drop in your credit score, which eliminates one of the main benefits of debt consolidation.
On the flipside, there's a potential to see an increase in your credit score, too. If you start making the single payment on time each month, that helps your score go up. If you have the new loan as well as your lines of credit open, you'll see a drop in your utilization rate, which also helps improve your credit score. It's recommended to keep your credit utilization at or below 30%.
Bid Debt Farewell With Approaches Tailored Toward Your Needs
Many of our customers wonder how debt consolidation works, and we're happy to explore different options with you. There are many factors to consider if you want to eliminate debt, lower your interest rates and improve your credit score. Debt consolidation can be great for some people but may not be the answer for others.
If you're considering consolidating your debt, we can help you find the lenders that can give you the best options. Reach out to Lendzi today for help managing your debt via our debt consolidation services.