With millions of Americans and Canadians steeped in debt, its paramount that we combat crippling interest rates whenever we can. Debt consolidation is one way in which this can be done, but how? When we take into account the multitude of ways we can consolidate debt to achieve lower interest rates, it becomes easy to get lost in its complicated landscape. In this post, we will get granular on some of the more common ways to consolidate debt, how to do it, and how to avoid pitfalls that can be detrimental to your financial well-being in the long-run.
Before we begin, we should probably take a moment out of our busy lives to define debt consolidation, and take a look at its potential advantages. Debt consolidation is nothing more than taking multiple debts and consolidating them into one, at a lower interest rate. Though this can be done in a variety of ways, the end goal is always to have one monthly payment to a single vendor, at a reduced interest rate. When done properly, debt consolidation gives you the ability to save money by paying down your principal amount faster with the money that otherwise would have been consumed by costly interest charges. Now that we understand what debt consolidation is, let’s take a leap into the details and look at the options available to you.
Consolidating With a Loan
Among one of the most common ways to consolidate debt is by taking out a loan and using to eradicate all of your other debt. The goal is to find a loan from a reputable lender with a substantially lower interest rate than you are currently paying. Though, this should only be done if you have a relatively healthy credit score. If your credit score is low, you will likely be offered a loan with an extremely high interest rate and the application process could impact your credit. If you have poor credit, it’s probably best to avoid trying to get a debt consolidation loan altogether:
Do get a consolidation loan if:
- You have good credit and will get a lower interest rate
- Your debt is below $50,000
- You have ample cash flow to pay down the principal amount quickly
Don’t get a consolidation loan if:
- You have bad credit and will not be approved for a low interest rate
- Have substantial levels of debt (you will likely not get the amount you are looking for and impact your credit by applying)
If you are interested in learning more about debt consolidation loans, for American readers, I’d suggest checking out The Simple Dollar’s useful resource on debt consolidation, and if you are reading from Canada, you can check out this comprehensive guide on debt consolidation loans. Both of these resources are worth taking a look at if you are looking to learn about debt consolidation loans in general.
Consolidating With Home Equity
Consolidating by using the home equity you’ve built up over time can be your saviour from debts with hefty interest rates. Mortgages inherently have lower interest rates relative to loans, credit cards and other forms of debt. Consolidating with your mortgage can be done in a couple of different ways.
Firstly, you can refinance your mortgage and use the money you recieve to pay off your other debts. You can also use your mortgage to secure a line of credit or a loan. By taking out a secured line of credit or loan, you will typically receive a lower interest rate because the debt is secured against collateral. However, consolidating using your mortgage can hurt you down the road. For many people, mortgages act as a virtual savings account which is commonly used for retirement and unexpected emergency expenses.
Do Consolidate With Your Mortgage If:
- You can use your mortgage to secure a lower interest rate and have the ability to safely make monthly payments
- Your home equity is substantially larger than the debt you are seeking to consolidate
Don’t Consolidate With Your Mortgage If:
- You are in danger of jeopardizing your assets by not being able to make monthly payments
- Have substantially high levels of debt that exceed or are equal to the amount of equity you have in your house
If you would like to learn more about consolidating by using your mortgage, check out The American Government’s take on debt consolidation.
Using Credit Cards to Consolidate
It may seem counterintuitive to use a credit card, which normally has a high interest rate to consolidate debt, however, it can be beneficial. If you have good credit, you can normally get a credit card that has a lower interest rate. If you have a credit card you have been paying on for several years, you may very well have improved your credit enough to qualify for another credit card. If you decide to take this route, find a credit card with a promotional offer.
Do use a credit card to consolidate debt if:
- If you already have a credit and have improved your credit
- You can take advantage of a low interest rate promotional offer
Don’t use a credit card to consolidate debt if:
- You already have multiple credit cards
- You are unlikely to get approved for a credit card with a lower interest rate