What is debt consolidation
When you’re in debt, whatever you do feels like your hands are tied and you can’t save. Then people think about what debt consolidation is – how can one more debt help?
Of course, you are right to be distrustful, because consolidation can really either help or drive you into an even more desperate situation.
It will allow you to pay off your debt faster, but if you go to places you didn’t really need to, you will end up spending more time repaying.
So, what is debt consolidation, how to consolidate debt, what are the pros and cons of it, and how to find a reputable organization?
What is debt consolidation?
This is essentially a refinancing: you combine your debts into one payment at a reduced monthly interest rate by taking out another loan. Debt Consolidation Example: You have three credit card debts:
- A: 30,000 🪙 at 15% per annum
- B: 10,000 🪙 at 20% per annum
- B: 50,000 🪙 at 12% per annum
Every month you deposit 1000 🪙 for each card, but part of the money for each payment is eaten up by interest. When consolidating debt, you take out a loan of 90,000 🪙 and repay all of the above debt, receiving an interest rate of 10%. You will pay more, which in theory means that you will get out of debt faster.
The interest rate you can get depends on what type of loan you are getting:
- A secured loan is when you provide an asset (such as a car or house) as collateral. If you default on your loan, your lender will take the said asset.
- An unsecured loan is a loan without collateral. It usually has higher interest rates.
Problems with debt consolidation
This way of managing finances has its drawbacks. Think about them before you immediately agree to the offer of “get out of debt in 2 hours."
1 Paying off your debt may take longer
First, while in theory debt can be repaid faster, in real life the opposite is true. Imagine saving a few thousand in interest payments: what would you spend it on? The bank will most likely be the last place you take your money.
Willpower is a limited resource, and it’s the reason why we can’t skimp on coffee, dinner at restaurants, or pay off credit quickly. That is, it turns out that in many cases we pay the debt longer, respectively, give more finance.
2 You may lose your house or car
By taking out a secured loan and leaving something of value as collateral, you could lose much more than a few thousand 🪙. By taking out a mortgage, you risk your home. Of course, there are also advantages, such as a low interest rate, but you always need to objectively assess the risks.
3 Your credit history will suffer
It will be more difficult to take out a loan next time, because the bank has not earned on you. At the bank, employees did some work, spent time on you, but got nothing out of it.
How do you know if consolidation is needed?
Debt consolidation can be a great tool, but it’s not always the perfect solution for everyone. You can make payments easier, save money on interest, and possibly pay off your debt faster. This path suits you if:
- You have high interest debt
- You have several high-interest debts
- If you have a good credit history (otherwise, there may be difficulties with banks);
- If you need fixed deadlines: for example, to pay off a credit card debt, you need more willpower.
Debt consolidation will not work for you if you have a bad credit history, if you are on the verge of bankruptcy, or if you cannot afford the monthly payments.
How to consolidate debt
If you still want to consolidate debt, avoid scam services, which, alas, are now a great many. They are trying to cheat by hiding additional fees, inflated interest rates, and long loan terms.
Calculate how profitable and where it is better to refinance. Find out interest rates, maturities, negotiate and close the deal.
After that, the hardest part begins: you need to get rid of the temptation to use your credit cards until you get rid of debt. If you ever want to pay off your debt, it must not increase. Remove credit cards as far as possible. The harder it is for you to get them, the more time you will have to figure out if you really need that product or service.
Avoid debt in the future
Once you’ve decided on a debt reduction method, don’t stop. Paying off debt is only part of financial literacy, and the other part is learning how to manage money so that you don’t end up in the same position you were before.
Keep track of how much and when you spend. It often happens that various little things accumulate, which crawl out into a round sum. Start saving the money you save by refinancing. This is the best way to avoid getting into debt again if you suddenly need to make a large purchase.