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The Pros and Cons of Debt Consolidation

The American people are drowning in debt. In fact, the average American has roughly $38,000 in personal debt. This alarming figure does not even include home mortgages.

The debt crisis starts at a young age. With their parents in debt, college students are financing their education. The result is that the average college graduate leaves school with over $35,000.

The weight of loan debt places a heavy financial and mental burden on your family. The good news is that there are vehicles to alleviate your debt issues.  

Read on for a comprehensive guide to debt consolidation. Explore the pros and cons of debt consolidation to start getting yourself out of debt today.

What Is Debt Consolidation?

Today, there are so many forms of debt. It seems like you can take out a loan anywhere. Customers waiting in line at Target or Kohl’s are often asked out to take a line of credit.

This leads many down a path with multiple credit lines. Paying multiple lenders each month can become overwhelming. It becomes difficult to juggle the due dates and minimum required payments from several different lenders.

The solution is to apply for debt consolidation. Here, you combine multiple credit obligations into one.

The lender starts off by paying all your creditors. Next, they roll up the outstanding balances of each loan into one larger balance. Now you will establish a new loan term and start making one monthly payment against the balance.

What Loan Types Are Eligible for Debt Consolidation?

One of the pros of debt consolidation is that many loan types are eligible. Credit card debt, one of the most nefarious types, is acceptable.

Personal and business loans are also eligible for consolidation. A growing problem in personal finance is medical debt. In fact, medical debt is putting unexpected hardship on approximately 137 million Americans.

Loan consolidation can combine credit card and medical debt into one payment. Private student loans are also acceptable for a consolidation plan.

What Loan Types Are Not Eligible for Consolidation?

However, one con of debt consolidation is that it does not accept every loan type. For instance, public student loans are not eligible for consolidation.

This means that loans offered by the U.S. Department of Education or a state government are not accepted. In addition to student loans, any loan taken from the government is not eligible.

Americans are also saddled with debt from vehicles and homes. Unfortunately, auto loans and mortgages are not accepted into this consolidation solution. Finally, debt from taxes, utility bills, or lawsuits cannot be rolled into a consolidation plan.

What Is the Primary Benefit of Debt Consolidation?

The number one reason that people turn to debt consolidation is to lower their payment. This is achieved in two different ways.

Reducing Interest

First, your main goal in a consolidation plan is to lower your financing costs. You are not going to be able to change the amount of principal on your loans.

Debt consolidation does not waive or forgive any portion of your debt. Something like this is possible in a bankruptcy proceeding.

In order to reduce your monthly payment, therefore, you will need to lower the interest rate. This will cut your total financial obligation by reducing the amount paid towards interest.

Envision a scenario in which you have multiple loans with variable interest. On your worst loan, the variable interest rate has spiked to over 15 percent.

Debt consolidation will allow you to purge yourself of high-risk variable interest loans. Instead, you can secure a consolidated loan with a fixed interest rate. Also, you can reduce interest expenses by receiving a much lower interest rate.

Extending the Loan Term

The second way to reduce your monthly payment is by extending the loan term. This option is not going to save you any money.

In fact, it may cause you to pay more in interest expenses over the long run. Extending the loan term is a double-edged sword in terms of pros and cons. The pro is reduced monthly payments, while the con is the potential for increased interest expenses.

However, some people need relief for their monthly budget and extending the loan term will deliver it. Extending the term basically spreads your principal and interest payments over a longer period of time. This provides a significant reduction in your monthly obligation.

Envision a situation in which you have $50,000 on a 5-year private student loan. You seek to consolidate this debt, along with a credit card balance, on a new 10-year term. Your monthly payment will undoubtedly come down.

Do You Have to Put Money Down?

Most debt consolidation plans do not require you to make a down payment. This is another benefit of seeking a consolidated loan.

Many loan types require that you put money down. For example, this is the industry standard for home loans. Many auto loans also require a down payment.

A down payment is a common requirement for lenders. It reduces risk to the lender as they receive money upfront and it minimizes their potential for loss.

What Is the Impact on Your Credit Score?

Another factor to consider in seeking debt consolidation is the impact on your credit score. Like extending the term, credit score impact is a double-edged sword. There are both pros and cons from a credit score perspective.

Debt consolidation will certainly help your credit score as outstanding balances are paid off. However, you will also see a hard inquiry and a new account opened. Both of these actions tend to lower a score.

You will also have a new line of credit that is maxed out initially. Your credit score is impacted by the percentage of credit compared to your credit limit.

Until you pay down the balance, Equifax and Transunion will show this as a negative. Ultimately, this temporary decline is still better than lowering monthly payments through a bankruptcy proceeding.

Pros and Cons of Debt Consolidation – A Recap

Being underwater with debt is a tough spot for any person. You may find relief in pursuing a debt consolidation plan.

You can acquire a lower interest rate and reduce your monthly payments. If you want to learn more about the pros and cons of debt consolidation, contact us today to learn more.

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