Debt consolidation is a tool that helps borrowers gather all their debts into one payment. Having a single loan can be beneficial for those with a medium-sized amount of debt that's spread out over a lot of different accounts. Borrowers who take this route of loan consolidation can also save on interest payments if the interest rate of the new loan is lower than the individual creditors APR. However, consolidation loans can also be harmful in some financial situations. The tips below will help you decide when it would not be in your best interest to take out a consolidation loan.
1. Low credit scores
For borrowers, having a low credit score means that you may not be able to qualify for a low-interest loan. A lower interest rate is the key reason to get a consolidation loan in the first place. It's counterproductive to roll all those bills into another loan with a higher APR.
2. Small debt load
If the borrower's debt load can be paid in full within 6-12 months at their average pace of payments, rolling them into a consolidation loan may not be worth it. The savings a consolidated loan represents may be minimal compared to simply quickly paying off the other loans. Alternatively, if the debt is credit card based, an option here might be a balance transfer to roll all of those balances into a new credit card with a lower APR.
3. High debt load
If your debt load is more than half of your income, then you may have a hard time getting a good rate on a consolidation loan. In addition, you want to be sure that you have a proactive plan in place to reduce that debt as quickly as possible, since high debt loads can be dangerous if there’s an interruption to your income, or other unavoidable expenses arise.
4. Job and Lifestyle changes
What happens if you lose your job, and have to take one that pays less? Are you ready to cut your spending to adjust to your income change? Borrowers who fail to adapt their lifestyles to match what they're making per month to avoid running up fresh debt may find that a consolidation loan only provides temporary help. In this scenario, a consolidation loan may still help, but careful budgeting is also critical.
This ties in with the lifestyle and psychological changes that need to be made. Some borrowers feel that debt consolidation solves their problems single-handedly. While consolidating your debts to reduce interest expense is an important tool, it is likely not the only one you will need. You still need to pay off that loan, and also make sure that you have a budget in place to keep your finances in order going forward. Do your research to find the best rates and the best repayment terms, and also take stock of your financial situation and your spending habits to make sure you have a solid plan in place.
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