Ask an expert: Debt consolidation

A: A debt consolidation loan can help anyone who is carrying high-interest debt, whether it’s credit-card balances or finance-company loans, such as those you may have been enticed to take out to finance furniture or other large purchases. Consolidating with a lower interest loan will help you save on interest, and having one payment can make looking after your finances simpler, too.

If you own a home, the least expensive way to consolidate and refinance consumer debts right now is to use a home equity loan or line of credit. Because these loans are secured by the paid-up value of your home, lenders charge a lower rate of interest for them. If you do not own a home, you may find a personal loan is your best option for consolidating other debts.

Here’s how debt consolidation works: add up all of your outstanding consumer debts, then apply for a single loan large enough to allow you to pay them all off at once. Because most consolidation loans carry a lower rate of interest than credit cards and finance-company loans, you save money on interest each month, and make just one payment instead of several. For example, if you had $30,000 in outstanding credit-card debt, at 18 percent interest, you would be making payments of $600 a month towards the interest and principal. If you consolidated that debt into a loan at six percent, your payment would go down to $497 a month over a 30-year term.

If you choose to pay the same amount each month as you did before consolidating your debts, you will save money because more of the monthly payment goes to principal, instead of interest. You won’t have more cash in your pocket, but you will be debt-free sooner.

If you find it difficult to make your current consumer loan payments, the lower interest rate on the consolidation loan will allow you to reduce your monthly payment. You may not pay the consolidation loan off any sooner than you would have retired the consumer debts it replaces, but you will still be saving money on interest.

The interest rate on your consolidation loan will partly depend on how credit-worthy you are. When you apply for a loan to consolidate debt, lenders look at factors such as your income and your history of paying bills and other debts. Typically, the better your credit record, the lower the rate of interest a lender will charge you.

And don’t forget, if you consolidate debt with a home equity loan, the interest on that loan is generally tax deductible. But, as always, check with your tax preparer to determine eligibility.

Dan Moore
Vice President, Product Management

 

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