Debt Consolidation Explained

Written By Naazma Garcia
Oct 27, 2022


Keeping your head above water is difficult when you’re stuck in the deep end of auto loans, student loans, medical debt, credit card debt, and other personal loans. 

If you have different credit commitments and are struggling to keep up with repayments, you might be looking for a way out.

Perhaps you’ve read about different debt relief options and are wondering if debt consolidation is a smart move.

Here’s everything you need to know if you’re thinking about consolidating your credit card or other debt. 

What is Debt Consolidation?

This is a form of debt refinancing whereby several smaller debts, typically high-interest debt like credit card bills, are merged into one simplified loan with more favorable terms than you had before. 

Debt consolidation generally results in a lower interest rate, lower monthly payments, and a simplified payment plan.

You can apply for debt consolidation through different resources such as your bank, credit union, or credit card company. 

If you’re unable to pursue such options, you can opt for private lenders.

How Debt Consolidation Works

In a nutshell, how debt consolidation works is you borrow enough money to pay off all your current debts and owe money to just one lender.

Dealing with multiple bills with different payments, interest rates, and due dates can be daunting. An easier way is taking out a new loan and then using the loan proceeds to pay off your other individual debts.

You can apply for a balance transfer credit card, personal loan, or another consolidation tool through a financial institution. Once all your pre-existing debts are paid off with the new loan funds, you will make a single payment on the new loan every month.

Say, for instance, you have three outstanding credit cards with the following balances and interest rates:

  • Credit card A: $6,500, 17.90% APR
  • Credit card B: $5,000, 21.50% APR
  • Credit card C: $3,500, 25.00% APR

Under this example, you have $15,000 in outstanding credit card debt across three cards, with APRs ranging from 17-25 percent. 

If your credit score has gone up since you applied for your existing cards, you may qualify for a 0 percent or low-interest balance transfer card that will let you pay off these cards interest-free for a set period. 

Alternatively, you might apply for a debt consolidation loan with an APR lower than your current rates.

When Is Debt Consolidation a Good Idea?

Debt consolidation is a sound approach when:

  • Your monthly debt payments (including mortgage/rent) do not exceed 50 percent of your monthly gross income.
  • Your cash flow consistently covers payments toward your debt.
  • Your credit is good enough to qualify for a low-interest debt consolidation loan or 0 percent balance transfer card.
  • You can pay off the consolidation loan over a more extended period.
  • You have a plan in place to avoid racking up new debt. 
Forms of Debt Consolidation

There are two primary forms of debt, both of which roll your debt payments into one monthly bill.

  • Balance Transfer Credit Card

The 2021 Experian Consumer Credit Review reports that the average American carries $5,221 in credit card debt, and according to the Fed’s most recent data, the average APR is about 16.27 percent.

Assuming you only make the minimum payment every month, it would take you over 17 years to pay off this balance. 

A 0 percent or low-interest balance transfer card is the cheapest way to consolidate your credit card debts, provided you complete payments within the promotional period.

These cards offer an introductory APR promotion for new customers that typically lasts 12-21 months. 

Failing to repay the full balance before the introductory period ends means you’ll continue to accrue standard interest on the remaining balance. So, ensure you can repay the balance in full before the intro period is over.

You’ll need a good or excellent credit score to qualify for a balance transfer card and might have to pay a balance transfer fee (3-5 percent of the transferred amount).

  • Debt Consolidation Loan

A debt consolidation loan is a type of personal loan worth considering if you can afford to keep up payments until the loan is repaid.

Debt consolidation loans are typically available through traditional banks, credit unions, and online lenders. You can qualify for this loan if you have bad or fair credit, but you’ll likely qualify for lower rates if your rating is high.

It’s important to know the type of debt consolidation loan you take out.

There are two types of debt consolidation loans:

  • Secured – Here, the amount you’ve borrowed is secured against an asset, typically your car or home (sometimes called homeowner loans). You might be offered a secured loan if you have a poor credit history or owe a lot of money. Missing repayments means you could lose your car or home.
  • Unsecured – Here, the loan isn’t secured against your home or other assets. The lender cannot take your personal valuables if you miss payments.

When you take out a debt consolidation loan, you’ll likely receive funds from the lender directly and then use those funds to pay off your old debts. 

However, some lenders pay off creditors directly. 

Debt consolidation loans generally have fixed interest rates. Repayment terms generally range from 12 to 60 months.

Debt Consolidation Vs. Debt Settlement 

Consumers always confuse these two debt payment strategies, but there are some vital differences.

 As mentioned, debt consolidation is a sound approach if you have a high credit rating and are able to keep up with loan payments. However, this method doesn’t erase the original debt.

If your debt is overwhelming and you’re incapable of keeping up with payments, you may want to consider debt settlement instead. This strategy involves hiring a third-party company to negotiate with your creditors to clear your debt. 

Since they’d rather get some payment than no payment at all, some creditors might let you pay  less than the amount you owe, sometimes as much as 50 percent less.

You can use both approaches simultaneously to pay down debt faster. 

Does Debt Consolidation Hurt My Credit?

Debt consolidation might hurt your credit rating in the short term but improve it in the long term. 

When you apply for a new loan, submit to a hard credit inquiry, and close old loan accounts, you’ll notice a small drop in your credit score.

That said, the reason for taking out a consolidation loan is to pay off debt more easily, which could improve your credit score over time, making you more attractive to future lenders. 

Paying down debt and making on-time payments are effective ways to improve your credit score.

What If My Consolidation Loan Application Is Denied?

Your consolidation loan application can be denied for various reasons, but a common culprit is a low credit score. 

If the lender denies your request, it might be worth applying with a different one, as you might find some lenders are less strict.

If your second application isn’t successful, a professional can help you weigh your options.

Conclusion 

Debt consolidation can be a good idea if you qualify for a low enough interest rate.

If you want to proceed with debt consolidation, Americor has debt experts who might be able to find the most suitable product for your needs.

Don’t let credit card debt become a burden in your life.

Click here to apply: https://apply.americor.com/new 

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