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Juggling multiple types of debt can make it difficult to save for long-term financial goals, such as purchasing a vehicle or house. Debt consolidation doesn’t get rid of this debt, but it can alleviate the burden of tracking multiple payments and dealing with high interest rates.
Debt consolidation is a method of combining all outstanding debt into a single line of credit. You can consolidate multiple credit cards or a mix of credit, such as a mortgage, a vehicle loan and medical bills. Debt consolidation not only organizes your debt into a single payment but can also offer a smaller interest rate.
There are several debt consolidation methods to choose from. Each one carries its own benefits and risks, making it important to educate yourself on potential impacts. Ultimately, the best choice depends on your credit score and the amount of debt owed.
A balance transfer card allows you to integrate your debt into a single card with a lower interest rate. Many of these cards offer a promotional period with 0% interest ranging from 6 to 21 months. This helps you access lower payments and eliminate your debt interest-free during that time.
Qualifying for a balance transfer card typically requires having good to excellent credit. Additionally, some cards charge a fee ranging from 3% to 5% of the amount being transferred, which can be significant if you have a large amount of debt.
Applying for a balance transfer card can also add a hard inquiry to your credit report and lower your score. Credit utilization partially impacts your score as well. Transferring significant amounts of money can raise your credit utilization ratio for that specific card, negatively affecting your score.
Personal loans provide a lump sum you can use to pay off multiple lines of credit. You then make payments to the loan according to your lender agreement. Most personal loans come with fixed interest rates and terms, meaning you don’t have to worry about your payment unexpectedly changing.
If used correctly, personal loans can improve your credit score by diversifying your credit mix. However, you need a good credit score to qualify for low interest rates and other favorable loan terms.
A 401(k) retirement account allows you to borrow up to half the amount under $50,000 to pay off debt. Borrowing from a 401(k) doesn’t adversely affect your credit score, although you must pay the amount back within 5 years and make at least quarterly payments. Borrowing this money also doesn’t accrue interest since it isn’t from a lender.
Despite its perks, borrowing money from a 401(k) to alleviate short-term debt can significantly impact your retirement savings. You may lose out on money you would’ve made if the funds had remained in the account. Additionally, you risk owing additional taxes and incurring other penalties, especially if you can’t pay the money back.
If you’re a homeowner, you can use a home equity loan or line of credit to pay off your debt.
A home equity loan offers a lump sum that operates like a personal loan, with interest rates and regular payments.
A home equity line of credit works like a credit card, meaning you only borrow what you need and repay it. Then you can use it again if needed.
Tapping into home equity carries the highest risk. Although it may not significantly impact your credit score, it requires using your home as collateral. This means failing to repay the debt can result in losing your home.
To summarize: debt consolidation loans hurt your credit if they aren’t managed correctly. However, they can also reduce the overall amount you owe and offer other perks that can improve your credit.
Exploring the pros and cons of debt consolidation can help determine if it’s the appropriate financial strategy for your situation.
Debt consolidation can help you:
If debt consolidation doesn’t work for your situation, that’s okay. Other debt management methods may provide needed relief.
Debt management programs connect you with a counselor who negotiates with creditors on your behalf to score more favorable terms, such as lower interest rates. You then make payments to the agency instead of your creditors. Consulting a debt management counselor doesn’t affect your score, but entering into a debt management plan can.
A debt settlement procedure involves negotiating directly with creditors to reduce your monthly payments or interest rates. Debt settlements can remain on your credit report for 7 to 10 years, impacting your ability to open new lines of credit. However, if you have massive debt and a settlement helps you pay it off faster, this may benefit you long-term.
Ultimately, whether you decide to consolidate your debt or pursue an alternative debt relief method, it’s important to choose an option that benefits your credit the most. Consider consulting a financial advisor for further guidance. If you’re curious about where your credit currently stands, you can take our free credit assessment to see your FICO score and a short summary of your credit report.
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