According to the Federal Reserve Bank of New York, the total U.S. household debt is sitting at a whopping $16 trillion as of Q2 2022. This makes our outstanding balances around $2 trillion higher than they were before the COVID pandemic.
In other words, if you’re like most of us, you may have seen an uptick in the amount of debt you’re carrying in recent years. This added debt can be worrying, leaving you to consider your options when it comes to debt relief.
If you’ve heard the term “debt consolidation,” you may have even started to wonder, “Is debt consolidation a good idea for me?”
The answer to that question, like all finance questions, depends on your personal situation. Let’s take a closer look at debt consolidation, its benefits, and when it may be the right choice.
What Is Debt Consolidation?
Before we get started, what is debt consolidation, anyway?
Debt consolidation allows borrowers to combine two or more debts into a single loan. This combination can change the terms of the loan, including the interest rate.
You can consolidate debt in two main ways. We’ve covered these in more depth in this post, but here’s a quick breakdown:
- Get a balance transfer credit card with a promotional 0% interest rate, giving you time to pay down your debt without interest during.
- Opt for a debt consolidation loan, which will usually offer you lower interest rates than what your current payments demand.
Other options include borrowing from your home equity or retirement accounts. However, we don’t recommend these, as both involve a fair amount of risk if you default.
How Do Debt Consolidation Loans Work?
When you take out this type of loan, you’ll apply for an amount of money equal to the amount of debt you need to pay off. Your new lender will then pay back your existing creditors on your behalf, or they’ll deposit the specified amount of money into your bank account for you to do it yourself.
Once this process is complete, you’ll pay back your single debt consolidation loan instead of managing multiple loans.
What Are the Benefits of Debt Consolidation Loans?
Thinking of consolidating debt through a single loan? If you opt to use a debt consolidation loan to better manage your debt, you’ll enjoy a few key benefits:
Lower Interest Rates
For most borrowers, the main benefit of a debt consolidation loan is the lower interest. This is especially true if you’re repaying multiple outstanding balances on credit cards with high interest rates. Depending on the amount of money you’re paying back, this change could save you hundreds or even thousands of dollars.
If you want to get on the fast track to a debt-free life, debt consolidation loans may be the way to go. Because you’ll have lower interest rates, you’ll be able to put the money you’re saving toward your total debt, meaning faster repayment overall.
Struggling to keep track of multiple loans with varied due dates can be stressful. With a debt consolidation loan, you’ll only need to pay attention to a single monthly payment, which can make budgeting much easier. If you’re the type of borrower who misses occasional payments when juggling due dates—thus racking up late fees and interest—a single loan is always the better option.
It’s true that the inquiry process of taking out another loan can put a temporary dent in your credit score, but a debt consolidation loan can often help your score in the long run. These loans make it easier to stick to a payment schedule, which is one key to raising your score. Even better, if you seek a debt consolidation loan for credit card debt, keeping your old cards open can improve your credit utilization ratio.
Is Debt Consolidation a Good Idea for You?
Given the benefits above, you probably won’t be surprised to learn that debt consolidation is often a smart move for borrowers with multiple sources of debt. However, it’s a good idea to consider your mindset, current debts, and spending habits before you take the leap.
Debt consolidation may be a good idea for borrowers who:
- Have a small or manageable amount of debt
- Can pay off their debt consolidation loan within five years
- Struggle to manage multiple monthly payment dates
- Have existing high-interest debts
- Want an easy way to repay debts fast
- Need to quickly pay off an auto loan to avoid a car repossession
For the right borrower, debt consolidation loans can be a light at the end of the tunnel. Because they allow you to make fixed payments on a schedule with lower interest, they can be a great way to streamline your path out of debt.
On the other hand, debt consolidation may not be a good idea for borrowers who:
- Already have loans with low interest rates
- Plan to continue spending outside their budget
- Can’t afford the new loan terms and payments
A debt repayment loan doesn’t make you debt-free, and it can’t fix existing poor spending habits. If you know you don’t have the mindset you need to curtail your spending habits, or if you’re already so deep in debt that you’d struggle to repay even a single new loan, this may not be the best option for you.
Instead, consider reaching out to your lender to work out a new payment plan. You might also want to opt for alternative strategies like debt settlement or credit counseling, both of which can help you address your reasons for getting into debt in the first place.
Make Your Debt More Manageable
At the end of the day, answering the question “Is a debt consolidation loan a good idea?” is always up to you. Before you take the leap, make sure to sit down and consider your current debts, your spending habits, and the pros and cons of these loans.
If you’re ready to consolidate debt and get a fixed, low-interest repayment plan, we’re here to help! Consider how much you’d like to borrow and apply now.