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5 Benefits of Debt Consolidation
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Debt consolidation is when you roll multiple debt payments into one, typically using a personal loan, balance-transfer credit card or home equity loan. When you move high-interest balances, such as those on credit cards, to a new loan or line of credit with a lower interest rate, you can reduce your repayment costs and reap other benefits.
Here are five key benefits of consolidating your debt:
- You can save money
- You can simplify your budget with fewer monthly bills
- You may be able to pay off your debt faster
- You may be able to lower your monthly payments
- Your credit score may go up
1. You can save money
The primary goal of debt consolidation is to save money. When weighing your debt consolidation options, you should look to save money on interest payments, whether that’s in the form of a lower interest rate or a faster repayment timeline.
A balance-transfer credit card may grant you the opportunity to pay off your debt at zero interest if you qualify for a card with a 0% APR introductory rate. However, you’d have to repay your debt during the introductory period, which typically lasts up to 18 months. Any remaining balance after the introductory period will be charged interest.
Using a personal loan or home equity loan for debt consolidation can help pay off your debt faster and save money on interest if you qualify for a lower rate than what you’re currently paying on your debt. The example below shows how this can be done assuming $8,000 in credit card debt:
|How a lower rate can save you money|
|Credit card||Personal loan|
|Monthly payment||29 months||24 months|
|Length of debt repayment||$344||$367|
|Total cost of debt||$9,667||$8,816|
|*2020 Federal Reserve data. Annual percentage rate (APR) is a measure of your cost of borrowing and includes the interest rate plus other fees. Available APRs may differ based on your location.|
2. You can simplify your budget with fewer monthly bills
It’s easy to miss a bill payment when you’re juggling multiple credit cards and loans. And just one missed payment can leave a damaging blemish on your credit report.
Debt consolidation lets you roll multiple monthly payments into one, which makes it easier to track your debt repayment progress and your bills so you don’t miss a payment and risk taking a hit to your credit score.
3. You may be able to pay off your debt faster
Without a payoff plan, it can feel like you’re just throwing money at your debt without making any progress. When you consolidate your debt, though, you’ll be able to set a timeline for when your debt will be paid off. Consider, for example, how these debt consolidation options can help you create a clear plan of repayment:
⟶ Personal loan or home equity loan: You’ll repay all your debts in one monthly installment over a fixed period of time, typically a few years. By increasing your monthly payments and lowering your interest rate, you’ll be able to repay your debt even faster.
⟶ Balance-transfer credit card: With a balance-transfer credit card, you’ll want to pay off your new credit card debt during the introductory 0% APR period. In doing so, you’ll avoid paying interest on the transferred debt. If you have a leftover balance when the introductory period ends, it will accrue interest based on the card’s regular APR.
4. You may be able to lower your monthly payments
It’s possible to pay off your debt faster with debt consolidation, but you can also choose to consolidate your debt on a longer timeline with lower monthly payments. Keep in mind that long-term loans will cost you more in interest over the long run, but it may free up room in your monthly budget if you’re struggling to make ends meet.
Consider paying off $8,000 in credit card debt on two different timelines using a personal loan in the example below:
|How loan length affects interest costs|
|Short-term loan||Long-term loan|
|Length of debt repayment||3 years||5 years|
|Total cost of debt||$9,227||$10,083|
|*2020 Federal Reserve data|
5. Your credit score may go up
Credit scores are a reflection of your ability to make on-time payments, but your payment history isn’t the only factor that determines your credit score. Credit reporting agencies also heavily weight your credit utilization ratio, which is the proportion of revolving credit you’re using compared to what you have available. Your credit utilization can take up as much as 30% of your credit score.
You’ll want to keep your credit utilization low to ensure your credit isn’t negatively affected (and of course to avoid unnecessary credit card interest charges). When you consolidate your debt with a personal loan or balance-transfer card, this could potentially open up the opportunity for new credit and help you pay down your existing debt, which will lower your credit utilization and may improve your credit score.
You can check and monitor your credit score for free on the LendingTree app.