In some situations, consolidating multiple small debts into one debt is a good idea that can help you become debt-free sooner. Debt consolidation is when you take out a larger loan and use the money to pay off several smaller debts. You now have only one monthly payment to handle.
Source: This article is based on an article first published by https://www.kreditguiden.se. A Swedish loan and debt management website. Some information has been changed to be relevant to the US market.
Are you stuck with high-interest debts such as credit card debt, short-term loans and over-due bills? If you get a loan with lower interest and use it to repay all the small high-interest debts, you will have less interest to pay each month. The money you save on interest payments, you can use to pay down the principal of the new loan quicker. The smaller the principal, the less money will go into monthly interest payments, so you can quickly get into a positive spiral.
Having to juggle multiple debts can be stressful, and it also increases the risk of accidentally missing to make a monthly payment. Then, the letters reminding you to pay the overdue bill start coming in, along with hefty overdue fees. It is easy to feel like you´re drowning in debt, and this in turn can trigger some pretty unsuitable coping behaviours, such as ignoring the debts completely.
For many, debt consolidation brings peace of mind. Instead of dealing with multiple debts to multiple creditors, you will have one bill to pay each month to one lender.
Having a multitude of small loans and credits can look bad on your credit report, especially if they signal a messy financial situation. You juggling a bunch of short-term high-interest loans can look pretty bad, e.g. if you are applying for a job and the potential employer wants to check your financial situation. Having one larger loan to a serious bank looks much better than having a multitude of ”desperation credits”.
Above, we explained how debt consolidation can help you become debt-free quicker. In some situations, however, that is not the best approach. If you are in a very tight spot financially, the best choice might be to utilize debt consolidation to prolong the repayment period. If you have one or more high-interest short-term credits and are struggling to honour your obligations, debt consolidation can help you by turning short-term credits into a longer-term loan. Select a repayment plan that your economy can handle. It is better to make small monthly payments for several years than ruin your creditworthiness by failing to quickly pay back a bunch of short-term credits.
There are many banks and other financial institutions that offer debt consolidation. You take out a loan with them, and the money is instantly used to pay off all your small debts.
Some banks and institutions will only do debt consolidation if the loan is secured as a second mortgage or home equity line of credit, while others are more flexible. Having something to put up as collateral will typically make it easier for you to negotiate a low-interest rate.