Debt consolidation is one of the best ways of reducing your interest payments to a single, affordable payment every month. It's also a great way to get organized and reduce your debt burden. There are many options you can choose to consolidate and get out of debt.
You can roll your debt onto a lower interest credit card, seek the help of a professional and reduce your debt payments into a manageable monthly payment, or roll your high interest debt into a relatively lower interest loan.
While all of these are great options, debt consolidation can go wrong as well. For instance, most people get caught up in trying to score the lowest interest rate and forget other important factors that increase debt. Here are five tips for debt consolidation you must remember before putting it into action.
Low interest rates are not most important
Low interest rates are great since they significantly reduce your debt payments. However, most people chase low rates and forget to eliminate the root problem that caused the debt in the first place. Whether it was a lack of fiscal discipline or overspending in a certain area of your budget, the root cause of your debt must be analyzed and mitigated as much as possible.
In some cases, such as student loan debt, this might not be practical. However, if your debt is consumer-related—such as credit card debt or borrowing too much money via personal loans—you must examine your financial habits and practice corrective behavior.
Maintaining a budget is a great way to start examining your financial habits since it forces you to track every penny you spend.
You must also remember that debt consolidation does not magically eliminate your debt. You're still liable to pay the amount you owe. It's just that the additional amount you pay above your principal reduces when debt is consolidated properly. People who fail to practice good financial habits view debt consolidation as an excuse to rack up even more debt and this defeats the purpose of consolidation.
Pay attention to loan terms
The term or length of a loan is an important variable to keep an eye on. In a quest to receive the lowest interest rate, it's easy to lose sight of your ultimate goal: Saving money by consolidating debt. Let's say you receive a reduced interest rate of 5% compared to your previous combined interest rate of 6.5%. That's a significant decrease.
However, if your consolidated loan lasts longer than your original debt, you aren't saving any money. You're merely extending the period you'll remain in debt. That doesn't solve any of your issues.
A good consolidation uses your interest rate and loan term as tools to save you money.
Always remember that saving money is the ultimate goal of debt consolidation. Put another way, you want to reduce the interest you pay throughout your loan. You can use the interest rate and loan term to achieve this goal.
Keep the total interest paid in mind when renegotiating your debt. For instance, if you reduce the loan term but keep the principal the same, you will end up with higher monthly payments. If you can afford these payments, then it's a good deal since you'll pay your debt off faster.
Remember your credit score
If you've managed to consolidate your debt and have reduced the interest you have to pay, you must turn your focus on improving your credit score. Bad debt payment habits damage your score, making it more expensive for you to repay your debts.
The good news is that post-consolidation, you have a golden opportunity to begin rebuilding your debt.
The more payments you make on time, the better your score will be. As much as possible, do not incur new debt since this will make it tougher for you to improve your score. Your overall credit limit usage is an important factor in determining your score, so keep it as low as possible.
You can do this by making your consolidated debt payments along with paying off single purchases on existing credit cards. Remember that closing your credit card accounts can potentially damage your credit score. This is because your overall credit limit decreases once an account is closed.
The best approach is to make a single, small purchase on your credit cards every month and pay it off immediately. This way, you keep your overall limit high, usage low, and establish a track record of on-time payments.
Seek help if overwhelmed
Getting deep into debt is embarrassing, and many people avoid seeking help due to this. However, if figuring out how you can consolidate your debt is overwhelming you, you must seek professional help. A credit counselor can save you a ton of money, thanks to their existing relationships with creditors.
In some cases, counselors can even have some of your debts waived. However, you should not approach one with the aim of eliminating outstanding debt. Instead, prepare a statement of your finances, bring all debt-related statements, and get ready to learn some new habits. A good credit counselor will create a debt repayment plan and educate you as well.
No matter how much your counselor reduces your debt, make sure you pay your debtors directly. Many counselors have their clients pay them via a single check and then pay debtors separately from that lump sum. However, this doesn't shift the debt burden away from you. If the counselor misses a payment, you'll pay the penalty.
If you're still averse to the idea of seeking professional help, then make sure you conduct your research online. Always educate yourself before deciding to go down the debt consolidation path.
Negotiation works wonders
Debt negotiation occurs in two forms when consolidating debt. The first occurs when your credit counselor negotiates terms directly with lenders. The second occurs indirectly when you compare terms on credit cards and personal loans and figure out which one offers the best deal. Either way, you must view debt repayment as a negotiation, and your objective is to secure the most favorable terms.
Take advantage of introductory low or no-interest offers on credit cards to extract maximum value. Make sure you understand the terms of the balance transfer and the length of the introductory period. Often, interest rates reset to high levels once the period expires. This can sink you further into debt.
Planning is the key. Make sure you understand your financial situation and the terms of the deal offered before making a choice.
Dent consolidation can seem intimidating, but approaching it one problem at a time will help you figure out your financial issues quickly. Keep the tips you've learned in this article in mind before consolidating your debts. You'll save money and return to a prudent financial path in no time!