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If you have several debts, e.g. credit card, personal loans, vehicle loan, and home loan, debt consolidation is a way to simplify your financial life and potentially reduce your interest rate. Consolidating your debts can be a strategic move for managing and repaying what you owe more effectively. However, it's not always the best option for everyone. Here is how to decide whether debt consolidation is right for you.
- You Have a Low-Interest Loan: Generally, debt consolidation refers to taking out a new loan to cover your existing debt. However, if you have an existing low-interest loan, i.e. a home loan, and you're able to take out further credit on it, you could consolidate your debt in this way. In doing so, you benefit from paying a lower interest rate compared to credit cards and personal loans, for example.
- You Have High Interest Rates on Current Debts: If you have several high-interest debts like credit card balances and personal loans, getting a new consolidation loan with a lower interest rate could save you money on interest payments. You need to make sure that the new interest rate will indeed be lower than your current one, however.
- You Struggle to Manage Multiple Payments: When keeping track of numerous payment due dates and amounts becomes too challenging, consolidating them into a single monthly payment can help simplify your finances. You would then make a single monthly payment towards a consolidated loan.
- You Have a Good Credit Score: To qualify for a consolidation loan with a favourable interest rate, you typically need a good credit score. If your credit score has improved since you took out your existing loans, consolidation could be beneficial. Here is an action plan for improving your credit score.
- You have a Stable Income Source: Having a reliable and stable income ensures that you can keep up with the new consolidated loan payment, which is essential for the consolidation strategy to be successful.
- You Have Financial Discipline: Consolidation requires discipline. If you are consolidating credit cards, for instance, it's crucial to control your spending to avoid running up new balances, which could worsen your financial situation.
- You Have a Plan to Pay Off Debt: Debt consolidation should be part of a broader financial strategy to get out of debt. It’s important to have a plan to not only make payments on the new loan but also to save and avoid future debt.
- Interest Rates are Favourable: The consolidation loan should have an interest rate that is lower than the weighted average of your current debts. Otherwise, consolidation might not be cost-effective.
- You Can Save Over Time: Calculate the total cost of your debts as they stand, including interest rates and payment periods. Compare this to the potential new loan terms to ensure consolidating would result in significant savings over time.
- The Psychological Benefit: Sometimes, having a single debt as opposed to many can provide a psychological advantage, making the task of paying off debt seem more manageable.
Debt consolidation can be a great tool, but it’s essential to carefully consider if it’s the right step for your personal financial situation. It’s also wise to consult with a financial advisor before deciding to consolidate.
Did you know that you can consolidate your debt without a loan? Debt review offers the same benefits, but with additional legal protection. Reach out to us to see if you qualify for debt review.