Life is sure to become stressful when you are constantly carrying a large load of debt. Managing payments and dealing with creditors is difficult when you can barely keep your head above water and struggle to make ends meet. Consumers can get into a vicious cycle of cash shortfalls and continue to use credit cards just to scrape by. When they approach the brink of insolvency, they begin to look for solutions that will keep them afloat.
Many consumers, in fact, millions are struggling with debt that consumes their thoughts every day. Much of the debt they are carrying is credit card debt. As of the end of the fourth quarter of 2022, Americans reached an all-time high in their levels of consumer debt. According to the Household Debt and Credit Report from the Federal Reserve Bank, household debt reached a whopping $16.90 trillion and credit card balances stood at $960 billion—this surpassed the pre-pandemic record of $927 billion.
With household debt soaring to new heights, many people are considering debt consolidation loans as a means to manage their overwhelming debt. While this type of debt relief can be a viable means to manage your finances, there are important pros and cons to consider and questions you should ask yourself before going down that path.
Before we cover those questions, let’s take a deeper dive into how debt consolidation loans can take the weight off your shoulders—and your finances.
What is a debt consolidation loan?
Debt consolidation loans combine your unsecured debts into one new loan with a single payment. You use the proceeds to resolve all your current qualified credit card debt, which puts an end to late payments and fees. You may be able save money by paying less interest on the new loan.
This would likely mean the new payment could be less than what you were previously responsible for. In addition, making only one payment per month instead of many streamlines the process. This can reduce stress by lessening the chance of your missing a payment while juggling many.
Reducing your cash outflow can provide a chance for you to get on top of your debt problem or put more money toward resolving it. Debt consolidation loans come in several forms and choosing the right one to fit your financial situation is important.
Many homeowners look to utilize the equity in their homes to address their debt issue. This is only possible, of course, if you owe substantially less on the mortgage than the home is worth. Many times, this equity comes via a Home Equity Line of Credit, or a HELOC.
If you receive approval for a line of credit, you are usually free to use the funds any way you wish, including as an effective way to consolidate your debt. HELOCs usually require you to have a large amount of equity in your home and the ability to show a verifiable source of income.
You could also choose to utilize the equity in your home by refinancing your mortgage and using the additional cash to resolve your debts. Another option is borrowing more money than your current home mortgage balance and using the excess to consolidate credit card debt into the mortgage.
As with a HELOC, you would need adequate equity and verifiable income to qualify for a home refinance.
If you have relatively low credit card balances, a personal loan might be a viable option. Banks and finance companies usually extend these loans to borrowers who are in good financial standing and aren’t dealing with a large amount of debt.
Interest rates on personal loans are usually less than what credit card companies charge. But the term of the loan is usually relatively short, compared to mortgage loans. Many borrowers take out these loans to get their credit card debt paid off quickly.
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The upside to debt consolidation loans
Debt consolidation loans can help you get on top of your financial issues. Here are some of the advantages of consolidating debt:
Just one payment
For many people, one of the more attractive aspects of obtaining a debt consolidation loan is combining all their debt payments into one simple payment. Having only one payment to make each month can help you stay organized and avoid missed and late payments.
Reduced payments
Most consumers consolidate their credit card debt to reduce the amount of money they pay each month. If you can get a lower interest rate, you could see substantially lower payments—depending on the length of the terms. This could help you save money for emergencies or pay more toward your debt each month.
Lower interest rates
Debt consolidation loans such as mortgage refinances, HELOCs, and personal loans will nearly always carry a lower interest rate than credit cards. As a result, you could make lower payments that can help you make ends meet and stop living paycheck to paycheck.
If enough money is saved each month, you might be able to create an emergency fund and enjoy some financial security for you and your family. This is a recommended protective measure that can ensure the funds are there when you are facing financial emergencies, such as costly medical bills, expensive car repairs, or even job loss.
Get caught up
If you have fallen behind on payments or are struggling to keep up, a debt consolidation loan can be a breath of fresh air. With your credit card accounts resolved, and debts consolidated into one monthly payment, you can stop worrying about late or missed payments. Instead, you can focus on what matters most: getting your financial life back on track.
The downside of debt consolidation loans
Debt consolidation loans carry some significant advantages for consumers who use them to address an oppressive debt problem. However, there are some potential drawbacks to be aware of when considering a consolidation loan.
You may be at risk of accumulating credit card debt again
When you work hard and maintain the self-discipline to pay off your credit cards one painful payment at a time, you learn valuable lessons about money management. Due to this, you are less likely to fall back into debt than those who have utilized a debt consolidation loan to address their debt problem.
Debt consolidation, especially mortgage-based consolidation loans, tends to “sweep debt under the rug” for many people. Many consider the process too simple, especially since it doesn’t teach better spending habits.
However, by not going through the difficult process of paying off debt through hard work, you could end up accumulating more debt on top of an already bigger mortgage. If this happens to a large degree, you could potentially put your home in danger of foreclosure if you are unable to meet your obligations.
You may pay more interest over the life of the loan
Rolling debt into a mortgage loan could mean that, even with a lower interest rate, you could end up paying more interest in the end. This is because mortgage loans have much longer loan terms. While they can vary, most are 30 years. Consider putting the numbers into a calculator to make sure that consolidating debts into the mortgage makes sense.
Your spending practices may not change
Unfortunately, many consumers do not change the way they manage their money after consolidating their credit card debts. If this is the case, they can find that not much changes for them after debt consolidation.
Many times, the extra cash flow created with debt consolidation is eaten by poor spending habits. Therefore, they may find themselves relying on credit cards once again to get through the month.
Three questions to ask before you get a debt consolidation loan
Before making the leap to consolidate credit cards and other debt, ask yourself these three questions to ensure you are making the best financial decision.
1. Have I made the necessary lifestyle changes to make debt consolidation successful for me?
It is important to recognize the circumstances that led you to debt in the first place. If you have been overspending or spending irresponsibly, this will need to change. If you continue to live above your means and start relying on credit cards to make ends meet, you will soon find yourself back to square one.
If your problem has arisen from circumstances beyond your control, such as an unexpected illness or injury or the loss of a job, make sure your situation has improved and that you will be able to meet your obligations moving forward. A debt consolidation loan can only make your financial situation worse if you continue to rack up debt as you pay down your new loan.
2. Have I chosen the right type of loan for my circumstances?
As mentioned above, several types of debt consolidation loans exist. It is important to remember that bundling your debts into your home mortgage comes with some risk.
If you are unable to meet your larger mortgage payment, you could be putting your most valuable asset at risk. Losing your home to foreclosure is a monumental, catastrophic event, so be sure you are not inviting that risk with a new debt consolidation loan.
If your debts are not too large, and you are looking to resolve them quickly and efficiently, you may consider a personal loan. Personal loans can be a good choice for those who have relatively small credit card balances.
3. Are there other options available other than a debt consolidation loan?
Debt consolidation can be a good option for many people but qualifying for a loan may come with considerable challenges if you have struggled financially for quite some time.
If you are willing to put in the hard work and remain diligent about resolving your credit card debt, you could potentially handle things on your own.
DIY debt management
Those who have the self-discipline to take on a DIY debt management strategy have a couple of options to consider. One is to simply look at your statement and determine, from the information on the front page, what payments are necessary to pay off your balance in three years.
All credit card companies must provide you with this information on their statements. By paying that amount every month without fail (for every card), you may be free from credit card debt in as little as 36 months.
Or you could use the “snowball method” where you pay as much as you can on the lowest balance every month. Then pay the minimum on everything else to avoid late fees. Once the lowest balance is paid in full, you move to the next lowest, and so on, until all debts are resolved.
Consumers who are unable to make any progress with their debt on their own and are unable to qualify for a debt consolidation loan might consider working with a debt relief company.
National Debt Relief debt settlement program is an alternative to debt consolidation loans and can help consumers settle their debts with creditors by negotiating a lower amount due, which is paid in a lump sum after sufficient funds have been accumulated in a dedicated savings account. While the process can take some time, it typically takes less time than declaring bankruptcy. In fact, you could resolve your debt in as little as 24-48 months.
Getting on top of a burdensome debt load can prove difficult. But if you take action before your back is up against the wall, you have a better chance of success.
