Debt consolidation can be tricky. The payments can be lower, but that total amount repaid over the term of the loan can be significantly higher due to the longer period of the loan.
A debt consolidation loan will simply transfer the debt to a new lender, although at manageable interest rates and terms, so you still have debt.
Also, it doesn’t help improve your credit score though it might be helpful in managing your monthly payments, so you can avoid late payments or missing the due dates.
Despite all the pros and cons of a debt consolidation loan, it is a good idea to have one especially when you are struggling with several high-interest loans.
Taking an unsecured personal loan to consolidate debt may not work in all cases as the rate of interest you might be offered may range anything from 6% to 25% depending on your credit history.
If you are low on credit score, you won’t find too many lenders offering you a rate that justifies the idea of debt consolidation.
How can you benefit from a debt consolidation loan?
Suppose you have three credit cards or loans with very high interest rates. Each of these has a rate more than 10% and a different loan term.
You approach a lender, such as Bank of America, Chase Bank, Wells Fargo or Capital One for a debt consolidation option. Your lender may suggest a number of ways (in the form of a personal loan, home equity loan or debt consolidation loan) for a better payment option.
- You may be offered a debt consolidation loan with a rate less than 10%. Your monthly payment will go down provided the new term will remain more or less the same as the existing ones. Plus, you have one single payment each month instead of three different payments.
- You may be offered a loan with almost the same interest rate as you have currently (combined), but your term is increased. This will result into lower monthly payments; however you need to pay more over the entire term of the loan due to the longer period of the loan.
If you take an unsecured personal loan to consolidate debt, then you are generally offered a loan term between 24 and 60 months. Also, you need to have a very good credit score to qualify for a personal loan under 10% of interest. All these factors make a personal loan suitable just for credit card debt consolidation.
How can an unsecured loan be helpful for debt consolidation?
Credit cards usually have very high interest rates. More importantly, if you are making the minimum monthly payments on credit card debt, you are likely to pay only the interest and not the actual principal.
As a result, your debt will remain as it is for several months, and even worse, you might cause the credit card interest rates to go up by missing payments or exceeding limits.
An unsecured personal loan will be a good idea to consolidate all your debt and pay off your credit card balances in full sooner.
The advantages of an unsecured personal loan over a credit card debt can include:
- A significantly lower interest rate
- Your interest rate will still remain lower even if you have a bad credit personal loan in most cases
- A flexible loan repayment term, which can range from 2 to 5 years
- A fixed monthly payment consisting of interest as well as a portion of your principal
- One single payment instead of several ones with varying dates, so you can easily keep track of your payment every month
- You can save money on interest and get out of your debt faster
Is it a good idea to use personal loan for debt consolidation?
It is a hotly debated issue and there can’t be one single answer. It depends from case to case. You can use a debt consolidation calculator to get a clear picture in your case.
For example, if you are offered with a personal loan that has more interest rate than the existing one, then it is definitely not a sensible idea to go for consolidating your debt.
One the other hand, a personal loan with a lower monthly payment and longer term can be useful if you are in financial difficulty at present.
If you can afford, you must always try to go for a personal loan that helps you pay faster and costs significantly lower over the term of the loan.