What is Debt Consolidation and Would it Benefit You?

  • April 8, 2022

What is Debt Consolidation?
Debt consolidation is when you take out a new loan to pay off multiple other debts, such as mortgages, student loans, credit card balances, and other liabilities into one monthly payment. Payments are then made on the new loan until it is repaid in full
 
When should you consider Debt Consolidation?
The main advantage of debt consolidation is that you will end up paying a lower interest rate overall when you combine all your debts. This allows you to pay lower monthly payments and free up cash for other obligations and investments.
 
What types of debt qualify to consolidate?
The best types of debt to consolidate are:

  1. Credit card debt— Interest rates on credit cards are notoriously high. On average, they range from 15% to 22%.
  2. Private student loans—especially if you have a mix of student loans at variable interest rates.
  3. Personal loan—a consolidation loan could score you a lower interest rate than when you first took out the loan.

 
Examples of Debt Consolidation
You have a mortgage with a Balance of $434,485 and credit cards and an equity loan totaling $139,455. The total monthly payments equal $5,350. By consolidating all monthly debts, we can decrease the monthly payment down to $3,382 over 20 years at a rate of 4.5% while the credit card rates range between 18-26%. If you were to continue paying the same monthly payment of $5,350 on the consolidated loan you could have the balance paid off even sooner saving an additional $140,549 over the life of the loan.

Or

You have 8 credit cards with a total balance of $44,900 and the interest rates average 20%. By just making your minimum payments of $696 a month it would take an average of 5 years to bring your balance down to $0 and cost approximately $13,000 in interest alone. If you were to use the equity in your home to consolidate debt you could lower your overall monthly payments while increasing your savings. The total monthly payment before consolidation including the mortgage is $1,171, after refinancing you would have one monthly payment of $740 and would be saving $63,330 in overall interest or $196 a month in interest alone.

Types of Debt Consolidation
Common ways to consolidate debt are:

Through a 0% interest, balance-transfer credit card. Consumer debt (i.e., not a mortgage) is transferred onto the card, and you pay off the balance in full before the promotional period ends. The credit card then charges you a lower interest rate than the original consumer debt. Creditworthiness is required (usually 690 or above) for this option.

Through a fixed-rate Debt Consolidation loan. The money from the loan pays off your other debts, and then you pay back the loan in installments over a set term. If your credit score is high, you may qualify for a lower interest rate (which will be much lower than your interest rates on your other debt).

Through a fixed or adjustable rate Cash-out Refinance. During a cash-out refinance, you replace your existing mortgage with a new loan for a higher amount and receive the difference in cash. The interest rate and length of your new loan will likely differ from your previous mortgage. Furthermore, the amount you owe will also increase since you are adding to your mortgage balance.

Through a unique product from Credit Union ONE called Max Refi. Similar to a debt consolidation loan, this fixed-rate loan requires no private mortgage insurance and no closing costs. Those seeking to consolidate their debt at a lower upfront cost will benefit from this product.
 
Requirements
You need to have the following to qualify for a debt consolidation loan: A steady source of income to pay off the loan on time. A good credit rating (690 or higher) will also give you a better chance of obtaining a lower interest rate than your previous debt.
 
When is Debt Consolidation not a good option?
This financial strategy isn’t a cure-all if you’re in debt. It won't change excessive spending habits, which create and perpetuate debt. Also, it won't help you if you are unable to pay back debt even after reducing payments or lowering the interest rate. If either of these scenarios applies to you, you may have to consider bankruptcy or other financial strategies.
 
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