It is no secret that many people who take on additional loans to be able to pay off their accumulated credit card debt ultimately end up in a situation that is worse than before; both their debt and levels of stress are more despite doing their best. On the other hand, there are folks who come out smiling at the end of the exercise.
There are many routes to achieving this happy state; switching debt to low-interest rate cards, undertaking a balance transfer to a zero percent card, getting a personal loan or a loan against your home to mention a few.
Consolidation: Use it like a Ladder to Get Out of the Mess
Most people go ahead and obtain a debt consolidation loan and pay off their accumulated debt with intent never to land up in the same situation again. However, because of their propensity to fund an extravagant lifestyle by swiping their credit cards without a worry in the world, they land up exactly in the same situation as before – the cards are maxed out and debtors are giving them hell for missing payments. What they have basically managed to do is to double their debt exposure in double-quick time and now there’s no escape.
The risk of consolidating your debt depends substantially on the type of loan that is taken. Typically, the interest rates on personal loans are far lower than that of credit cards. However, if you have not made the right choice, you could end with a deal that carries a substantially higher rate too. A range of 3-36% rate of interest has been seen in personal loans, so you’ve really got to do a lot of research to ensure that you get the best terms. Crucial to this are your credit score and debt-to-income ratio that indicates how much you can qualify for. The many online debt consolidation reviews available can give a better idea on the interest rates charged by the leading lenders.
Debt consolidation can also be done with a loan that is secured by a physical asset like a home or a motor vehicle. While this type of a loan carries a far lesser rate of interest, the danger is that if you default you could lose the asset used as the security, and if that happens to be your home, it could be disastrous.
Steps Involved In Doing Debt Consolidation the Right Way
Assess your financial situation: Add up all the debt that you have taken on and find out how much you are liable to pay per month. If the figure is half or more of your monthly income, seek out a credit counselor so that you are able to identify a reliable lender to give you a debt consolidation loan. See if you are able to schedule your repayments in such a way that you can emerge with a clean slate within five years, else you should consider filing for bankruptcy under Chapter 7, which may be able to get you off the hook in three to four months. A Chapter 13 filing, however, may involve a repayment plan stretching up to five years.
Shun high-cost loans: Be sure to calculate the actual interest you need to pay together with any applicable fees and charges involved in a debt consolidation loan. A simple back-of-the-envelope calculation of the monthly payment asked for multiplied by the number of months scheduled versus what you are currently paying will give you an indication of your savings, if any. This comparison is necessary because many lenders disguise very high-interest rates by scheduling the repayments over a very long time that drives the monthly payment down to a very low amount. To avoid unnecessary interest cost, opt for the shortest possible tenor; five years is the absolute maximum that you should consider.
Lock up your credit cards: Since uncontrolled credit card usage is the main reason for the debt trap most people land up in, you can consider closing all credit cards, save one, after taking a consolidation loan. However, since this might hurt your credit score, it is best if you can lock up your credit cards and avoid using them completely.
Debt consolidation has been strategically used in such a manner that you get the maximum benefit of being able to monitor your financial situation better and get the advantage of lower interest rates and the opportunity of restructuring your debt for a more affordable monthly payment. However, to make the exercise fruitful, you need to have a lot of self-discipline and be aware of the typical risks that might end up driving you deeper into debt.