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Consolidating Debt: When Does It Make Sense?

Aug. 04, 2017

Debt can be hard to crawl out of, especially when payments on credit cards, consumer loans and student loans continue to pile up on top of your living expenses. Overwhelmed with a blizzard of monthly bills, many people look at consolidation as an alternative. Streamlining debts can be a useful way of managing an unyielding financial burden and lowering costs, but it's not for everyone. Here are a few things to consider before jumping into it.

There are two major reasons to consider consolidation: to save money by getting a more favorable interest rate and to facilitate making payments on time.

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The case for consolidating: lower interest

Say you've been carrying a handful of credit cards with rates in double digits. If you've been making payments on time for a couple of years and have decent credit, you might qualify for a loan at a much lower interest rate. Canceling out your credit card debt with a cheaper loan could drastically reduce what you pay in interest over the life of the loan.

The fact that a loan has a set term also acts as a brake on the amount of interest you pay.

With credit card balances, a consumer can scrape along paying just the minimum, which often covers only interest and hardly tackles the principal. If you do that over the course of years, what you pay in interest on a purchase can end up being significantly more than the initial principal. With a loan, by contrast, the debt must be paid off by the end of the loan term.

The lure of fixed rates, simplified payments

If you have a variable rate loan, another reason to consolidate might be to nail down a fixed interest rate. With a fixed rate, you know what your interest costs will be, regardless of the movement of the market interest rate that determines whether variable rates rise or fall. That way, you won't run the risk of being hit with a rate increase.

Finally, if juggling a slew of credit card bills has caused you to forget a payment or two, consolidating might help. Making payments on time is key to having a good credit rating. If consolidating multiple debt payments into a single one can help you do that religiously, it might be worth considering.

How about student loans?

If you have student loan debt, the question of whether to consolidate becomes more complicated. Key factors include how quickly you want to pay off those loans and how much of your school debt is from federal loans, which have certain consumer protections that would be lost if they're rolled into a consolidated loan. There's also the fact that you can only consolidate student debt once, so you want to make sure you're choosing the most advantageous moment before doing it

When to avoid consolidation

If your debt can be paid off within six months to a year, the amount of money you would save by consolidating might not be worth the time and effort involved.

Consolidating should be a part of a larger strategy to decrease debt. It can be tempting to go on using your newly paid-down cards after consolidating. But doing so will only dig you deeper into the hole. Leave the cards open to help your credit score, but resist the urge to use them.

Looking to get started? Use a debt payoff calculator or talk to a certified credit counselor to figure out the right approach for you.

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