Debt consolidation is a financial tool that merges multiple debts into a single one and can be paid off through a management program or by a loan. It helps in clearing off high-interest, unsecured debts like credit card debts as it lowers the monthly payment by reducing the interest rate.
How Debt Consolidation Works
To make a debt consolidation work, first, calculate the total credit card payments you make every month and the average interest rate paid. The next step is to scrutinize your monthly budget and calculate how much you spend on necessities like housing, utilities, food, and transportation. The leftover amount is what you have to pay down your debts that month.
If the balance amount is not enough to clear your payment due that month, that’s where a debt consolidation loan or debt consolidation management program enters. You need to make a single monthly payment to reduce your debts and can track your progress.
Debt Consolidation With A Loan
Getting a loan large enough to clear all your unsecured debts in one go from a credit union, online lender or a bank is the conventional way of consolidating debt. Normally, the repayment period is between 3 and 5 years.
A key aspect of taking a debt consolidation loan is that the interest rate you negotiate with your lender should be less than what you are currently paying on your unsecured debts. If the interest rate on the new loan is more or the same as the current rate, it is redundant to take a debt consolidation loan as you don’t reduce the amount you’ve to pay off. Your credit score heavily influences the interest rate the lender will offer you.
Debt Consolidation Without A Loan
You can also consolidate debt by asking a credit counseling agency to offer you a debt management program for nonprofit debt consolidation. This saves you the trouble of having to take out another loan.
The agency works with the credit card companies to lower the interest rate, eventually lowering your monthly payments to an optimum level. Every month, you’ve to make your payment to the credit counseling agency, which then distributes the amount agreed upon to the creditors. It can take 3-5 years to clear off your debts using this method, and missing a payment can cause the concessions on your interest rate to be revoked.
