Is Debt Consolidation Right For You?


Getting Your Debt In Check

According to Federal Reserve and other government data, American consumer debt is up to $11.6 trillion as of November 2014. This statistic combines home, auto, and student loans, as well as credit card debt nationwide. With the average credit card holder having at least three cards, and U.S. household’s averaging around $153,000 in mortgage debt, this can amount to a whole lot of payments to cover each month. Unfortunately, simply ignoring these debts won’t make them go away. Addressing the problems and figuring out the best way to deal with them will help considerably, though. This is where debt consolidation can help you. Consolidating your debt allows you to pay off all your smaller loans with one single loan, making your overall debt easier to manage. But how do you know if debt consolidation is right for you or which method would work best? Here’s some information to help you figure it out. SEE ASLO: Pinging Your Credit Report: The Consequences

What Is Debt Consolidation?

Consolidating your debt basically just means combining your debt. In most cases, a lower interest loan is taken out to cover your multiple charges—credit cards and other loan accounts—leaving you with just one monthly payment to worry about. It’s important to understand, though, that consolidation doesn’t lessen what you owe, it just makes it easier to keep track of and manage.

Your Choices of Debt Consolidation

There are several methods of consolidation you can choose from, depending on your personal preference and the status of your credit. If you have bad credit, for example, there are several types of debt consolidation programs that might work for you, but you should talk to a credit counselor to help you figure out which one is best for you situation. If you have good credit and can resist the temptation of overusing your credit, taking out a new credit card with lower interest to pay for everything, coupled with plain old do-it-yourself budgeting might be all you need. However, if the lure of using your credit is something you can’t avoid, you should consider taking out a loan. The two most common debt consolidation loans are cash-out refinancing and home equity line of credit (HELOC), both of which are ways to access your home equity. They both have their benefits and risks, but learning more about them will help you determine which loan is best for you.

Cash-Out Refinancing

When you do a cash-out refinance, you pay off your current mortgage balance and replace it with one that has a lower interest rate and higher loan amount, allowing you to pocket the difference from your previous mortgage. This is what you would use to pay off your debt. Not only do you get access to the lump sum, but the lower interest rate also means lower monthly payments. However, getting a new mortgage will reset your loan term, extending the length of time before you can pay off your home. High closing costs and the numerous fees that come with refinancing are also things to take into account, so make sure you find out what those are first to determine if the loan is worth it. The biggest risk with this loan, however, is that you’re putting your home up as collateral. Therefore, you can lose your home if you fail to make your payments.

Home Equity Line Of Credit

A HELOC, on the other hand, is a second mortgage rather than a new one. This means that you’ll still have to make payments from your first mortgage, but the loan you receive will come from the equity of your home, which you can use to take care of your debt.  Once your first mortgage is paid off, you will then make payments for the second one. The good thing about HELOCs is that you can borrow money as you need it, like a credit card, and only be charged interest for what you borrow. Say you get approved for a $35,000 HELOC, but only draw out $10,000 here, and $15,000 there; you’ll only have to pay interest for the $25,000 you borrowed. Plus, there’s usually little to no closing costs to worry about. Like with cash-out refinancing, though, failure to make payments can cost you your home. Also, HELOCs tend to have higher interest rates that can vary depending on the market, increasing your monthly mortgage payment. SEE ALSO: Comparing Your Options: Cash-Out Refi Vs HELOC

The Bottom Line

The main thing to remember when it comes to debt consolidation is that it only works successfully if you exercise a little bit of self-control. Whether you have good credit or bad credit, consolidation can take care of your debts, but only for the short term. It treats your debt problem; it doesn’t cure it. In order to be completely debt free, you need to budget and make sure to only spend what you can afford. Otherwise, you can risk losing everything, including your home.
Date of original publication:
Updated on: November 10, 2015

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