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Should I Consolidate or Pay Off?

Personal Insights

Credit card debt continues to grow in America. A popular way to get out of debt faster is by using a debt consolidation loan. There are many different types of debt consolidation and debt management plans. However this isn’t always the best option.

Why Consolidate?

Debt consolidation loans typically work by using the proceeds of the loan to pay off all of the other creditors. Consolidating debt into a single loan will mean:

  • A lower interest rate. This can take years off debt repayment and help you save a significant amount of money. (Ensure that the APR on your new loan is lower than the APR on your existing debt).
  • An easier way to pay. If debt exists across multiple credit cards, managing all of the accounts can be difficult. Consolidation will be one payment. (The APR is still the most important consideration, so avoid paying a higher interest rate for the convenience of consolidation).
  • A higher credit score. With maxed out credit cards, utilization ratio is very high and can put a huge damper on your credit score. Paying off credit cards with a loan will reduce the utilization on your cards.

Ways to Consolidate

Some of the most popular consolidation methods include:

  • Personal Loans. Obtaining a personal loan with a low interest rate has become increasingly easy since the rise of marketplace lenders. Most lenders will allow you to shop for an interest rate without hurting your credit score.
  • Home Equity Loans and Lines of Credit. Home equity loans offer low interest rate and the ability to deduct the interest. However, you put your home at risk and tempt yourself with extending the term. Credit unions offer particularly low interest rates.
  • Credit Card Balance Transfers. Credit card companies offer rates as low as 0% as an incentive to win new customers. With excellent credit score and low debt, a balance transfer could be the cheapest option.

The Risks of Consolidation

Consolidating your debt to a lower interest rate personal loan is a way to get out of debt faster. However, there is a big risk to using a debt consolidation loan. Once you pay off your credit cards, you will be tempted with a lot of newly available credit. If you got into debt because you spent too much money on credit cards, creating more spending power on your credit cards is a dangerous strategy.

You cannot borrow your way out of debt. With consolidation, people believe they’ve done something about the debt problem but its still there (and so are the habits that caused it), it’s just moved.

Before considering consolidation, ask yourself why you got into debt in the first place. Consolidation can be used as a helpful tool if your spending is under control, you have a written budget and you are working hard to get out of debt. But you may end up in even more debt if you aren’t careful.

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