The start of a new year is an ideal time to look at your personal finances and decide what changes may be needed to improve your financial wellness in the coming months. One area that is often first on the list is your debt. If you have multiple loans that you are paying each month, consolidating your debt could be the right move.
A debt consolidation lets you combine your various loans into one loan with a single monthly payment. This will make it easier to track and, depending on your credit, could also save you money on interest that you are currently paying separately on your loans. In this blog, we will discuss the options available so you can identify the best way to consolidate debt.
What Does Consolidation Do to Your Credit?
When you consolidate your debt, you combine your accumulated loans into one new loan, which will have a single monthly payment. This lets you reduce the number of separate bill payments you will make each month and could reduce the amount of interest you will pay overtime, according to Investopedia.com. Some financial institutions may even offer introductory APRs (annual percentage rates) on their loan products to encourage you to consolidate with them and save money on interest payments.
A debt consolidation could improve your credit score if you continue to make your monthly payments and lower the existing balance. A key tip here is to not run up new balances on those loan accounts that were paid off in the consolidation.
When’s the Right Time to Consolidate?
It is important to evaluate your monthly budget regularly to see if there is any chance to combine loans, especially if you can get a lower interest rate. Take note of how many loan accounts you have open, the total amount you owe on each account, the total amount of monthly payments made on them, and the interest rates you pay for each account. If you discover that combining your debt will lower the amount you pay each month and you can obtain a lower interest rate on your loan, consolidation may help simplify your finances, according to Investopedia.com.
Ways to Consolidate Debt
There are different loan products you can use to consolidate debt. Financial institutions, such as credit unions and banks, will have an array of lending products that can do this. Selecting the right lender and the right product will depend on many factors, including the interest rate offered, the term of the loan and the lender itself. It’s best to explore products from several lenders before determining the best course of action for your needs.
- Credit Cards: Credit cards are one of the more common tools that can be used to consolidate debt. They’re generally offered through credit unions, banks and other lenders. It’s important to compare interest rates of credit cards to find the best deal. Credit cards tend to have higher interest rates than personal loans and can cost you more the longer you hold a balance. Other things to look for are balance transfer fees, which can be costly. Typically, such fees are charged as a percentage of the balance transferred, according to ConsumerFinance.gov.
Some credit card companies offer introductory APRs which are lower for a set amount of time, saving you some money at the start. But once that introductory period ends, you’ll pay a higher interest rate so it’s best to review all disclosures to fully understand the timeframe of the promotional rate and what the standard rate will be once the introductory period ends.
- Personal Loans: Personal loans are another financial product that can be used to consolidate debt. Personal loans typically offer lower interest rates than credit cards and come with a fixed term, depending on your lender. With a personal loan, you will receive a set amount of money to pay off your consolidated balances and will pay it back with fixed monthly payments during a set amount of time, says Investopedia.com.
Unlike credit cards, your interest rate and monthly payments will remain the same throughout the life of the loan. In addition, depending on your credit worthiness, you may be able to select the length of the term, which gives you more financial flexibility.
- Home Equity Loan or HELOC: Tapping into your home’s equity is another way to consolidate your debt. Both a home equity line of credit (HELOC) and a home equity loan are good options for homeowners. There are a few differences between both types of equity loans, but both use your home as collateral.
A HELOC is a revolving line of credit which allows you to borrow from and pay back the loan in a pre-determined amount of time. The interest rate on a HELOC is variable and will fluctuate depending on market conditions. A home equity loan is similar to a personal loan. It gives you a lump sum of money with a fixed interest rate that you will need to pay back over a certain period.
Interest rates on a home equity loans can be lower than credit cards and personal loans, according to Bankrate.com. Because both a home equity loan and a HELOC use your home as collateral, you will not be able to sell your home until you pay off these loans. Keep in mind these loans have longer funded terms and may not be suitable for individuals who want to consolidate their debt sooner.
Risks of Debt Consolidation
While there are several ways to consolidate debt, there are some risks to keep in mind. For example, your credit score could be negatively impacted by having another large loan added to your credit report. Additionally, once you pay off old accounts, those lenders may close them, which could mean losing some of your credit history. This could potentially affect whether you qualify for other new loans, says Investopedia.com.
Another risk to consider is the total amount of interest you will be paying for the consolidation loan. If you extend the term to the maximum allowed, you will end up with a lower monthly payment but could pay a lot more in interest by the time the loan is paid off. A good tip is to review the proposed loan’s amortization schedule to see how much interest and principal will be applied with each payment. Plus, you can also see how making extra payments can help lower this interest.
How TCU Can Help
Travis Credit Union can help you with your debt consolidation as well as provide you with the tools and resources to help you plan, save, spend and borrow better. Our credit cards, personal loans and home equity loan products can get you started on the road to financial wellness. Visit traviscu.org for details.