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Debt Consolidation

Debt consolidation is a form of debt restructuring that combines several loans into one, mainly for two reasons: to lower either the interest rate or to lower the monthly payment amount. With a good consolidation loan, it is possible to lower both. Another possible reason people consolidate loans is simplicity; instead of dealing with multiple different loans, debts, and payments each month, a consolidated loan only requires one, relieving hassle and saving time.

Most loans will require the payment of upfront fees. As a result, the real cost (real APR) of loans is higher than the interest rates advertised by lenders. This calculator can determine the real APR of consolidated loans after adjusting for applicable fees, which is the more accurate and comparable indicator of the financial cost of a loan.

Home equity loans, home equity line of credits, and cash-out refinances are common sources of funds used for debt consolidation. These are secured loans that are tied to collateral, such as real estate properties, generally lower risk for lenders, which lowers interest rates. On the other hand, unsecured loans can also be used to consolidate debts, such as personal loans or balance-transfer credit cards. They tend to have higher interest rates and lower loan limits because there is no collateral attached to them.

Considerations

Before consolidating loans, there are some considerations to keep in mind.

• Besides the interest rate, the loan fees or points are major costs of a loan. Because the purpose of debt consolidation is to lower the costs of debts, any additional fees on top are not helpful. This is made evident by the calculator; using the default figures as given, a 5% loan fee makes debt consolidation a financially feasible decision. However, if the loan fee is changed to 15%, the new consolidated loan is no longer worth it due to the heavy fee cost required to consolidate the prior loans, as pointed out by the red text. As a result, it is important to consider the loan fees or points when it comes to debt consolidation.
• The process of consolidating debt is not quick but tends to be tedious and drawn out. It involves evaluating a person's financial situation with a credit counselor in order to ponder necessary actions.
• Extending the term of a loan may results in more interest payments over a time period, though this may be canceled out by more favorable conditions in the consolidated loan, such as a lower real APR. The calculator can help evaluate this.
• Debt consolidation may lower credit scores, depending on the chosen option. Credit scores and credit reports can only ever receive positive marks as long as routine, timely payments are made each month. With that said, any application for new credit is considered a hard inquiry into credit history, which generally lowers credit scores. However, as long as timely monthly payments are made, this dip in credit score tends to be short-term. Credit scores also depend on a person's credit utilization ratio, which is the amount of debt that they carry as compared to the total amount of debt that is available to them. For instance, consolidation using a personal loan to pay off credit cards can make a utilization ratio go down, which is good for credit scores. However, in this same scenario, the credit score can go down if a credit agency believes it to be a risky loan.

Fix the Real Problem First

While effective loan consolidation can possibly lower the financial burden, it is worth considering tackling the root of the burdens first, whatever it may be. For many people, this is a change in habits such as spending less and saving more. For others, it may be a journey towards learning how to live within or below their means. In some cases, it can even be seeking a higher income. These are few examples of methods that will be more effective in the long term in erasing debt, as opposed to just simply consolidating them. In any case, budgets are practical ways to sort financial situations before the question of whether or not to consolidate loans pops up.