Debt consolidation may be a good option for those looking to lower their monthly payments – but is it the right option for you?
Debt consolidation can be an appealing option for anyone who’s struggling to manage multiple monthly payments.
"Debt consolidation is essentially taking multiple debts and putting them together so you have just one monthly payment," says Daniel Lawler, a Branch Team Leader for Regions Bank.
Ideally, the consolidated process will lower your monthly payments and reduce your interest expenses. "If you're struggling to pay your bills, spread too thin, or you don't have the necessary cash flow, it may be a good time to consider debt consolidation," says Lawler.
Where to Start
If you're considering consolidating your debts, Lawler recommends first gathering your various bills and determining the total amount owed and the various interest rates. Then use the Regions Debt Consolidation Calculator to find out how much you can reduce your monthly payments.
Collect the last two years of tax returns (as well as your homeowner's insurance information if you plan to apply for a home equity loan) and consider talking to a financial professional about your options.
Credit Cards
If you aren’t able to leverage home equity, many credit cards have zero percent balance transfer rates — which can mean you get a new credit card, transfer all of your other cards' balances over to it and pay no interest on the debt during the introductory promotional period.
Before going this route, make sure you can pay off your transferred balances in full before the end of this promotional period. After that period passes, the interest rate on the transferred balances is likely to increase significantly and may be higher than the rates that had applied before you transferred the balances. As you’re considering whether to go this route, also make sure to find out whether the balance transfers are subject to a balance transfer fee, and whether any other fees or restrictions apply.
Personal Loan
Another option is to take out a secured or unsecured personal loan. The main difference between a secured and unsecured loan is the collateral requirement. Collateral, like an owned vehicle or home, can be used as leverage for a secured loan and may result in a lower rate than an unsecured loan, which doesn't require collateral. A downside of secured debt consolidation is that if you default on the loan, you may risk losing your collateral.
Staying on Track After Consolidating Your Debts
After consolidating your debt, it's important to create a monthly budget and keep your spending in check. "Don't run up the balances on your cards again," Lawler says. "But don't immediately close out your cards, either. Figure out what route will help you accomplish your financial goals while also helping you build your credit score."
If it makes sense to keep the cards open, use them sparingly, and try not to carry more than 30% of debt in relation to your limits on each card.
"Also, if it's possible, make more than the minimum payment on your loans," Lawler says. "Even a little more each month can really cut into the amount of interest you'll pay."
Debt can weigh on you, but you may be able to lessen the load through consolidation. Remember to carefully research your options and calculate the total cost of all options to determine if debt consolidation is right for you.
Home Equity Loans or Lines of Credit
If you have equity in your home — meaning you owe less than its market value — a home equity loan or line of credit can be a good way to consolidate your debt. The main drawback is that you are mortgaging your home. So, if you do not make your payments on time, fail to maintain your Homeowner’s Insurance, or don’t pay your taxes, you may lose your house.
"Home equity loans and lines of credit generally have lower interest rates than personal loans, unsecured loans, and most credit cards," Lawler says. "If you have sufficient equity, you may be able to borrow enough to pay off all of your bills, and then have just one structured payment to make each month." If you are struggling to pay your debt already, you need to think very carefully before you mortgage your home.
For example, imagine you have $20,000 in debt between balances on a credit card, a student loan, and an auto loan, and your monthly minimum payments for these three debts totals to $900. If you take out a $20,000 home equity loan or open a line of credit and use it to pay off those balances, you'll clear those individual debts in favor of one single payment. If you have a 60-month term on the loan at a 6% interest rate, your monthly payment will be $387. In this situation, you would have slashed your monthly payments by nearly 60%.
It’s important to note that if you consolidate your debt into a longer repayment period; or at a higher interest rate; or if there are additional costs and fees associated with the loan, you may pay more money over the life of the loan. Be sure to calculate your total cost under each scenario before determining which route is better for you.
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