Is Debt Consolidation a Good Idea? What You Need to Know

Americans currently have $12.58 trillion dollars worth of debt. Out of that amount, $412 billion is seriously delinquent. 

There are a few ways we can work down that debt. We can find part-time work, sell off items we no longer need or declare bankruptcy.

We can also consider debt consolidation. There are pros and cons to debt consolidation. The cons often leave people wondering, is debt consolidation a good idea? 

If you want to find out the answer to how does debt consolidation work, keep reading. We’re sharing with you everything you need to know to make an informed decision about your finances. 

What Is Debt Consolidation and Is Debt Consolidation a Good Idea?

Debt consolidation is the act of rolling all of your high-interest debts into a single payment with a lower interest. Doing so can often help reduce your total debt.

Debt consolidation also reorganizes your debts in a way to help you pay it off more quickly. There are a few ways you can consolidate your debt.

Transfer Debt to One Credit Card

You can apply for a 0% interest, balance-transfer credit card. However, you will need to pay off the entire balance before the promotional period ends. 

Debt Consolidation Loan

Debt consolidation loans can also help you pay off your debts. You’ll then pay back the loan in installments over a set period of time. 

Other Options

You can also take out a home equity loan or a 401(k) loan. However, there is much risk involved in these types of loans. 

You may end up losing your retirement funds or worse, your home. 

When Debt Consolidation Is a Good Idea

Is debt consolidation worth it? In certain scenarios, yes. But before you make any final decisions, crunch the numbers first. If the math works out, debt consolidation may be worth it. 

Also, if you’re struggling with your debts and can’t negotiate lower interest rate terms with your credit card companies or creditors, debt consolidation may be the best option for you. 

Debt Consolidation Turns Many Bills into One Lump Sum

Debt consolidation is also a good idea for people who are struggling with:

• High-interest rates
• High monthly payments
• Too many bills

How does debt consolidation work? By combining them all into one bill, you’ll have a lower interest rate and a lower monthly payment. You may even be able to pay off your debts at a fraction of the cost. 

When Transferring Your Debt to a New Credit Card Won’t Work

Transferring your debt to a credit card doesn’t work if your debt exceeds the credit limit. In other cases, the card issuer may not allow you to transfer the amount you need to a card.

Some credit cards place restrictions on what kinds of debt you can transfer to a card. And if you don’t pay off the balance by the time the introductory offer expires, you could find yourself paying more than you would for a loan. 

When Debt Consolidation Isn’t the Best Choice

Does debt consolidation work? Not always. Here are a few times when debt consolidation isn’t the best choice. 

Can’t Get a Lowered Interest Rate

Debt consolidation loan companies look at the following factors:

• Credit history
• Income
• Expenses
• Debt

All of these help lenders decide if you’re a good risk. If your credit rating isn’t good, the lender may charge higher interest rates. 

If you can’t lower your interest rate, there’s no point in getting a new loan. You’ll end up paying more in the end. 

You Plan to Continue Spending

Debt consolidation of any sort doesn’t work if you don’t incorporate good spending habits into your lifestyle. If you transfer your credit card debt to a debt consolidation loan and then continue to use your cards, you’ll end up with an even worse financial situation. 

If you’re worried you might do this, try creating a budget and living on it for a few months before you take out a loan. If you can stick to your budget while making monthly payments, a loan may be a good idea. 

You Can’t Afford the Monthly Payments of a Debt Consolidation Loan

If your debts are so high that even consolidating them won’t make then affordable, you may want to consider debt settlement, credit counseling or trying to get your lenders to work out a more affordable payment plan. 

You’re Worried About Your Credit Score

Any form of debt consolidation impacts your credit score. In most cases, it’s a negative impact. 

That’s because older accounts have a more positive impact on your score because it shows a history of creditworthiness. By consolidating your debts, you close those accounts and replace them with a new account. 

If your score is already decent and you can manage monthly payments, you may want to explore other options. 

You Have to Pay Off Your Debt Consolidation Loan Quickly to Save Money

Before you agree to any type of debt program, do yourself a favor by digger a little deeper so you understand all the terms and potential fees. Find out if the interest rate is introductory.

If it is an introductory rate, find out when it expires and what the new interest rate will be. Do some math to figure out how many years it will take you to pay off your debts. Then calculate how much you’ll have paid out in interest by that point.

Ask About Possible Penalties

And always ask if you’ll be penalized for paying off your debts early. You should also find out what the penalties are for any missed or late payments. 

Think about your future. If you know of any upcoming changes such as an addition to the family or you’re starting your own business, what seems like a good idea today may not work out so well in a year or so. 

Keep Learning

Is debt consolidation a good idea? Only if you’ve done some research first and you have the money to pay down your debts. 

Only you can decide that. In the meantime, keep learning so you know how to make better financial decisions.