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It’s common to warn against taking out one loan to pay off another, but if the new loan is better it might be your best choice.
Debt consolidation can help you save time and money by lowering your interest rate and the terms of your finance.
What is debt consolidation?
Debt consolidation is when you combine several current debts into a single new debt.
While you still need to repay the money, debt consolidation can make paying your debts simpler because you’ll have fewer bills each month.
You may also end up paying less money overall by getting a lower interest rate.
Look for savings opportunities when market interest rates have fallen or your credit score has gone up.
Types of debt consolidation loans
Lenders may call certain loans debt consolidation loans, but almost any type of loan or line of credit can consolidate debt.
In general, people debt consolidation loans fall within one of three categories:
- Unsecured personal loans: For these you usually receive the full loan amount upfront and then repay the loan with fixed monthly payments over the repayment term. With a low interest rate and fixed payment amount, personal loans are a popular option for consolidating high-interest credit card debt.
- Secured loans: Some people turn to secured loans, often home equity loans or lines of credit, to consolidate debts.
These may give you low interest rates, but the lender can take your collateral (e.g. your home) if you miss payments.
- Balance transfer credit cards: Credit cards may offer a promotional 0% interest rate on balance transfers. This means you won’t have to pay interest on a debt for the promotional period.
If you have federal student loans, there’s also a special federal Direct Consolidation Loan.
Terms To Know
When you’re shopping around compare each of these terms to get the best deal:
- Fees: The most common fees are origination fees on installment loans or balance transfer fees on credit cards.
- Repayment period: Lenders usually offer different repayment terms. A longer term can lower your monthly payment, but it means more interest paid in the long term.
- Interest rates: Interest rates are generally shown as annual percentage rate (APR) ranges. Having good credit will help you get the best rate.
- Secured and unsecured loans: Secured loans offer lower rates at the cost of staking collateral (like a home). It’s best usually not to consolidate unsecured debt with a secured loan.
The danger of getting a debt consolidation loan
Losing collateral isn’t the only risk you take from consolidating debt.
In some cases, people will consolidate credit card debt and then wind up using their credit cards and get back into debt.
Before consolidating, make a plan to pay off the new loan. Be realistic.
If you think you’ll overspend with a credit card, work with a nonprofit credit counselor to build a plan.
Getting the best debt consolidation loan
Before getting a new loan or card, shop around to find the best offers.
Start by trying to get preapproved or prequalified for an unsecured personal loan with a soft credit inquiry.
Compare your estimated loan offers to your current debts.
Create or update your budget with a plan for paying off the debt consolidation loan or balance transfer card, and build in some wiggle room in case you can’t stick to the exact plan every month.
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