Last Updated on May 20, 2021 by MoneyVisual
Many families today carry a credit card balance month-to-month and don’t know how to go about getting out of debt. They can’t seem to get ahead regardless of what they do. Fortunately, people in this situation have options when it comes to obtaining relief from this debt.
Debt consolidation loans are nothing more than personal loans that can be used to pay off a debtor’s credit card balance. Only one payment must be made each month and the interest rate is generally lower than what the debtor was paying on his or her credit cards. To learn more about this type of loan, get assistance here.
How Debt Consolidation Loans Work
When a person chooses to obtain a debt consolidation loan, he or she knows how much must be paid each month to bring the debt down. There is no calculating monthly payments, interest rates, and juggling bills to try to pay down the highest balance or the card with the highest interest rate first. The interest rate that is paid will be based on the credit score at the time the loan was taken out.
Obtaining a Loan
Individuals will find they have numerous options when it comes to obtaining a loan of this type. Many turn to their local bank or credit union to try to secure these funds. However, when a person has a large debt load, the application may be denied.
The bank or credit union is hesitant to take on the risk of a person with massive debt. The concern is that the debtor will take out the loan, keep the other credit cards open, and run up more debt rather than paying off what is owed. For this reason, a person must consider different options when this is the case.
Furthermore, as a personal loan can be used for any purpose, the lender cannot force the borrower to pay off the existing debt. This adds to the risk taken on by the lender. However, there are companies willing to work with individuals who have debt they are struggling to pay and want to obtain a debt consolidation loan to solve this problem.
Choosing a Loan Provider
Debtors need to shop around when looking to obtain a debt consolidation loan. Compare the total lifetime cost of the loan by researching the total amount of interest that will be paid during the loan term. Compare this to the interest that will be paid if the loan is not obtained.
People often assume they will pay less simply because the APR is less. This may not be the case. It might be smarter to pay off the card in less time as less interest might be paid in this situation.
Be prepared to pay an origination fee. Many lenders charge approximately five percent of the total loan amount. This must be paid upfront, and borrowers do have the right to try to negotiate this fee. Doing so could lead to a higher APR or a repayment period that is longer.
Prepayment penalties are another thing to consider when comparing lenders. Certain lenders impose a fee if a borrower pays their loan off early. Avoid any loan that comes with this type of penalty.
Steps to Take After Obtaining the Loan
Once a loan has been secured, it’s time to pay off the debt and put the credit cards away. Keep one for emergencies but put the others in a location where they cannot be accessed. This ensures they are not used and more debt is not accumulated.
However, these cards can still be used to build one’s credit. For example, a person can choose to have their cell phone bill charged to one card each month and their trash service to another. Set it up so these payments are automatically deducted from the paycheck. Making regular payments on these cards will help to build the credit score once again.
In the event a card has to be used for a true emergency, choose the one with the lowest interest rate. Pay this balance off as soon as possible while still making the payments on the debt consolidation loan. If there is any doubt as to whether the situation is a true emergency, turn to a trusted advisor to get a second opinion. This helps to prevent purchases that truly aren’t needed.
Avoid canceling the credit cards, however. Doing so could have a negative impact on your credit score. The score drops because the amount of available credit decreases, and this is something the credit reporting agencies take into consideration when determining a person’s score.
Try to make additional payments on the debt. For example, a person who gets paid every two weeks can make an extra payment each year simply by having money taken from each paycheck to go to the loan. Every additional payment allows the loan to be paid off faster.
Never make a payment late or miss one. Doing so can be disastrous to the credit score. Be sure the loan payment is something you can easily afford each month.
Obtain help in establishing a budget so more debt is not accumulated. An experienced financial advisor can help determine where changes need to be made to the budget to ensure additional financial problems do not develop. Furthermore, this person will be of help in teaching the debtor how to avoid debt in the future and build wealth so this becomes less of an issue.
Debt consolidation is a great way to pay down overwhelming debt. Furthermore, this type of loan helps to simplify a person’s financial life. However, the debtor has to get his or her spending under control. Until this is done, the problem will continue and may even become worse. For this reason, no person should take on a debt consolidation loan unless they are committed to the process.
Doing so without this commitment can actually make a bad situation worse. Nobody wants this, so compare all options carefully to find the solution that is right for you. Many will find a debt consolidation loan is exactly what they need for a better financial future.