How Does Debt Consolidation Work – When Should We Go for It?

Consolidating your debt is a very tempting option when the multiple payments of unsecured debts overwhelm you.

Such debts usually include credit cards, payday loans, and lending companies. We understand that you may have no fixed income, and even if you do, not everyone can organize their expenses to stay current with payments.

For this reason, we made this article to explain how debt consolidation works and when it is the best option. Keep reading!

Let’s Get Started!

First, you need to understand that the real problem is your different debts but your expenses.

So your real goal is not simply to consolidate your payments into one; instead, you should aim to get rid of your debts, and for this, you need to establish a plan that helps you achieve it, not simply pay less for more time only once a month.

Understanding this point, one of the tools that could help you simplify your monthly payments and get rid of your debts is the consolidation of these, mainly if you are interested in low-interest debt consolidation loans.

Now, we can move on to explain how consolidation works, when it may be the best time to use it and other things.

How Does Debt Consolidation Work?

Regardless of whether you make an online debt consolidation or go to a specialized agency, the operation is generally the same:

After selecting the total of debts you wish to consolidate into one, an agency tells you how many of those debts they can absorb. Then, after selecting and approving debts, they are in charge of canceling them in their totality or establishing an agreement with your creditors for their cancellation.

Your duty here will be to pay a single amount to the agency that makes the consolidation loan once a month for a more extended period than if you did everything yourself.

–So, to answer the first FAQ, yes, you will pay more money in the long run-

Another way to consolidate is by qualifying for a debt consolidation loan. However, the previous method is relatively similar. In this case, you receive the total amount of your current debts with the creditors. You must use the money received to cancel all the loans, so you will only worry about making a single monthly payment.

A third alternative method to consolidate debts of different credit cards is the transfer of balance.

By transferring the balances of specific cards to a new one with a more attractive interest rate, you enjoy simplified payments and cost savings. In addition, many people take advantage of introductory offers of 0% interest during a specific period to advance their debt without the additional interest expense.

Debt Consolidation Rates

The idea of paying less money at a lower interest rate attracts a lot. However, understanding how exactly this system works will allow you to decide whether consolidation is for you or not.

At the outset, when you pay a loan ahead of time, you must pay a fine for advance payment. In addition, if your credit rating is not nearly excellent, you have few opportunities to obtain an attractive interest rate.

After these points, it is natural that all people expect to reach low-rate debt consolidation loans, but low-interest rates hide an uncomfortable truth.

Let’s Explain This With An Example:

Suppose you have $ 30,000 in debt, including a two-year loan for $ 10,000 at 12% and a four-year loan for $ 20,000 at 10%. Your monthly payments would be $ 517 and $ 583, respectively, for $ 1,100 each month.

Now, go to a company that proposes reducing your payment to $ 640 per month and the interest rate to 9% by negotiating with your creditors and combining the two loans. However, it will take you six years to repay the loan, and you will end up paying $ 46,080 to pay the new loan compared to $ 40,392 for the original separated loans. So, despite having a lower interest rate of 9%, you will spend an extra $ 5,688.

But don’t run away just yet! Debt consolidation is worth it if the situation calls for it!

When to Go To Debt Consolidation

Each case is unique, not all people have the same economic commitments or habits, but we can describe several parameters that can help you determine when to consolidate your debts is the best time.

The most important thing is that you examine your budgets to determine if you can comfortably pay the new monthly amount, do not forget that if your credit score is slightly deficient or just good, you are unlikely to get lower debt consolidation interest rates. Private companies offer up to 47% interest.

Dedicate as long as necessary to studying the different consolidation banks, and agencies offer you. Remember that credit cards also provide the possibility of requesting a new card with a promotional period of 0% interest and sums up your old debts.

Even if you think there are too many disadvantages, it could be the best option at your fingertips to avoid the defaults that do so much damage to your credit score and whose effect takes way more time to correct.

In other words, go for consolidation if you find yourself within any of these statements:

  • You found a low to 0 interest rate consolidation offer
  • If you are at risk of default handling the current payments by yourself
  • You forget to pay some debts every month and find it hard to organize so many payments

What Can Be Consolidated?

Debt consolidation can be used to simplify almost any type of unsecured debt. Therefore, it can include:

  • Credit cards
  • Medical bills
  • Service invoices
  • Payday loans
  • Student loans
  • Taxes
  • Invoices that have gone to collection.

Some people believe they will have advantages if they consolidate personal loans or loans with mortgage guarantees. It will depend on the analysis of your situation whether or not to include this class of loans in a consolidation.

Ways To Consolidate Debt

There are different ways to consolidate your debt which include:

  • A loan with a mortgage guarantee: This could be a relatively good option if you have a good amount of capital in your home.
  • The line of credit: lines of credit can be insured by your home, or your bank can offer you insurance if you have good credit and a good income, although if you pay the minimum, you can take a long time to pay.
  • Debt consolidation loan through a bank or credit union: This could be an option if you have a credit score and a good loan guarantee.
  • Debt consolidation loan through a financial company: your loan criteria are not as strict as those of banks. However, their interest rates can reach up to 47%.
  • Transfer credit card balance: credit cards mainly offer balance transfers with a low-interest rate as a means of debt consolidation.
    However, if you do not pay your balance at the end of the low-interest promotional period, you usually pay standard interest rates of around 20%.
  • Credit cards with low-interest rates: if banks or credit companies do not want to lend you money and you have a good credit rating, you could end up consolidating with a credit card with low interest.

Reasons to resort to debt consolidation.

People obtain debt consolidation loans for various reasons, all of which are well justified:

  • Simplifying finances replaces the exhausting process of paying multiple debts individually and on different dates for a single monthly payment.
  • You could save money by reducing your interest rate: achieved by paying a high-interest loan using a low-interest consolidation loan, without forgetting that your credit rating directly determines this possibility.
  • You can make life more straightforward with a smaller monthly payment: feasible if your debts are consolidated at a lower interest rate or if you have a more extended period to pay off the loan.
  • And you can pay the debt faster: this rarely happens. For it to be accurate, you must obtain a lower interest rate and, at the same time, keep your current monthly payment of the debt the same.
    The reason is that a more significant portion of your monthly payment is spent on your debt since interest consumes a smaller amount of money.

To Sum Up

Finding the tools at your disposal to deal with your debts is not a simple task, but it is well worth it.

Consolidation is one of those means to correct the effect that poor planning on our part in terms of expenses has on our credit scores. But it would help if you still organized your costs after consolidation to avoid unnecessary debt.

NoteA US bank discovered that 78% of people approved for a debt consolidation loan were not financially better after repaying the loan. Instead, these people had accumulated debt again.

You can enjoy good economic health whenever you make financial decisions with the mind instead of the heart. However, if you need consolidation, remember that it has practical advantages, creating a single payment and other aspects worthy of analysis before consolidating your debt to avoid backfiring.

Oscar Rojas
Oscar Rojas

I'm primarily a dad and a husband, then I live. I've been a freelance writer and editor since 2014, specializing in finance, casino, sports, and esports niches. I'm an expert in checking the small print on any T&C site. You can trust me as an expert, especially when it comes to financing and gambling products.