The biggest risks associated with debt consolidation include damage to your credit rating, fees, the possibility of not receiving low enough rates, and the possibility of losing any collateral you have deposited. Another danger of debt consolidation is ending up with more debt than you have at first, if you're not careful. Take our 3-minute quiz and talk to an advisor today. Founded in 1976, Bankrate has a long history of helping people make smart financial decisions.
We have maintained this reputation for more than four decades by demystifying the financial decision-making process and giving people confidence in the actions to take next. While a debt consolidation loan may initially lower your credit rating slightly because you'll need to do a thorough credit consultation, over time it's likely to improve your credit rating. This is because it will be easier to make timely payments. Your payment history accounts for 35 percent of your credit rating, so paying a single monthly bill when it's due should significantly increase your rating.
In addition, if any of your previous debts came from credit cards and you keep your cards open, you'll have a better credit utilization rate and a stronger credit history. Amounts due represent 30 percent of your credit rating, while the length of your credit history represents 15 percent. These two categories could lower your score if you close your cards after paying them. Keep them open to improve your credit rating.
In addition, since lenders often report a late payment to credit bureaus after it's been 30 days late, your credit rating can be seriously damaged. This can make it more difficult for you to qualify for future loans and get the best interest rate. When you consolidate debt, your total monthly payment is likely to decrease because future payments are spread over a new and, perhaps, extended loan term. While this can be advantageous from a monthly budget perspective, it means that you could pay more over the life of the loan, even with a lower interest rate.
You can create even more debt if you exhaust the new space available on credit cards. Debt consolidation loans typically include lower minimum payments, saving you the financial consequences of missing payments in the future. In short, you'll generally spend less on interest and pay back what you owe more quickly. Even if your interest rate drops during consolidation, you could still pay more interest over the life of the new loan.
However, these types of secured loans are much riskier for the borrower than a debt consolidation plan, since the borrower's home is used as collateral and non-payment can result in foreclosure. Before you are approved for a debt consolidation loan, lenders will evaluate your credit reports and credit scores to determine if they are offering you a loan and on what terms. For that reason, it's important to understand the pros and cons of debt consolidation before committing to a new loan. When looking for a lender, make sure you understand the real cost of each debt consolidation loan before you sign it on the dotted line.
Consolidating these debts into a single loan can streamline your finances, but the strategy may not solve the underlying financial challenges. You can consolidate multiple credit cards or a combination of credit cards and other loans, such as a student loan or mortgage. Doing so can save you money over the life of the loan, especially if you don't consolidate it with a long-term loan. Next, we discuss in more detail the possible impact on your credit when consolidating debt with a personal loan or credit card with balance transfer, as well as other debt consolidation options.
Before you apply for a debt consolidation loan, ask about fees, including late payments or prepayment of the loan. If you couldn't qualify for a lower interest rate than what you're already paying for your current loans, debt consolidation might not make sense. Debt consolidation loans are unsecured, meaning that the borrower doesn't have to put an asset at stake as collateral to back the loan. Debt consolidation may seem like immediate relief, but it may not solve the problem if issues such as overspending are not addressed.
Although it seems like an ideal solution, there are advantages and disadvantages associated with debt consolidation. If your credit score isn't high enough to qualify for a lower interest rate, it may not make sense to consolidate your debts. .