5 Things You Didn’t Know About Debt Consolidation Loans

5 Things You Didn’t Know About Debt Consolidation Loans

Debt consolidation loans allow you to combine multiple debts into one new loan, potentially lowering your monthly payments or interest rates. But there are some key things to know before taking out a debt consolidation loan.

1. Your Credit Score Matters

Your credit score plays a big role in determining if you qualify for a debt consolidation loan, and what interest rate you’ll pay. Lenders generally require a credit score of at least 620 to approve a debt consolidation loan. The higher your score, the lower interest rate you can qualify for.

Before applying, check your credit reports and scores so you know where you stand. If your score needs improvement, take steps like paying down balances and disputing errors before applying.

2. Your Monthly Payment May Not Decrease

The main goal of debt consolidation is to lower your monthly payments by extending your repayment term or lowering your interest rate. But that’s not always guaranteed.

If you currently have low-interest debts like federal student loans, consolidating could increase your rate and payment. Run the numbers carefully beforehand to see the impact on your monthly payment.

3. You May Pay More Interest Over Time

Even if debt consolidation lowers your monthly payment, you could end up paying more interest over the full repayment term. This is because consolidation loans typically have longer terms than credit cards or other debts.

For example, consolidating $10,000 in credit card debt with a 24% interest rate into a 5-year loan at 15% interest would lower your monthly payment. But you’d pay $2,000 more in interest over those 5 years.

4. Your Credit Utilization Ratio Will Improve

When you pay off multiple accounts with a consolidation loan, your credit utilization ratio will decrease. This ratio compares your total balances to your total credit limits.

Lower utilization signals lower credit risk and can quickly improve your credit score. Just be sure to keep balances low on the consolidation loan.

5. Missed Payments Hurt More

After consolidation, you’re making just one monthly payment instead of many. This simplifies things, but also means there’s more at stake if you miss or default.

With multiple accounts, one missed payment may not be a big deal. But missing the payment on a consolidation loan could tank your credit score fast.

Only consolidate if you’re confident you can make the monthly payments. Set up autopay as a safeguard against missed payments.

Debt consolidation can be a smart move if done carefully. But go in with your eyes open to both the pros and cons. Crunching the numbers beforehand helps ensure it will benefit your finances in the long run.

Sources:

• https://www.nationaldebtrelief.com/blog/debt-guide/debt-consolidation/5-things-you-didnt-know/
• https://studentaid.gov/articles/5-things-before-consolidating-student-loans/
• https://money.usnews.com/loans/personal-loans/articles/common-debt-consolidation-mistakes-to-avoid
• https://www.debtmd.com/blog/five-things-you-should-know-about-debt-consolidation
• https://www.forbes.com/advisor/personal-loans/pros-and-cons-of-debt-consolidation/
• https://www.consumerfinance.gov/ask-cfpb/what-do-i-need-to-know-if-im-thinking-about-consolidating-my-credit-card-debt-en-1861/