If mounting debt has become unmanageable and you truly need a solution, a consolidation loan could work out for you. However, not everything you may have heard about the financial strategy is true.
Let’s examine some common misperceptions.
What Is Loan Consolidation?
Essentially, debt consolidation is the process of combining multiple debts from credit cards and high-interest loans into a single monthly payment of the same amount each time. It can lower your interest rate and your payment and help you eliminate the debt faster. However, there are some debt consolidation myths that could be keeping you from taking out a loan.
Let’s take them one by one.
Debt Consolidation Myths
It hurts your credit: It is true that having and maintaining a solid credit score is key to your ability to borrow money. It’s also true that a loan application may necessitate a hard credit report inquiry, which can nick your credit. Over the long term, though, consolidation could help to improve your score.
For example, using a debt consolidation loan to eliminate credit card debt can improve your credit utilization ratio, which accounts for 35 percent of your score. What’s more, making timely payments on the personal loan could also bump up your score.
It decreases your debt load: Cool if it happened like that, but it doesn’t. Using a debt consolidation option to clear up credit card, student loan, or other debt doesn’t reduce what you owe. Rather, such a loan gives you the funds to pay those debts off. Moving forward, you will pay that loan off in monthly installments.
It’s also important to not mistake credit consolidation for debt settlements, which lets you get rid of debt for less than what you owe. Usually, this strategy is only available if you’re seriously delinquent on a debt, which can significantly hurt your credit score. Debt consolidation is the better option if your aim is to pay off debt while maintaining good credit.
The process is lengthy: Another myth about debt consolidation is applying for a loan is time-consuming. In fact, you can apply for personal loans for debt consolidation online and get a decision almost immediately. In other cases, the entire process may only take from a few days to a week. Gathering documents such as bank statements and pay stubs before applying will speed up the process.
You’ll always save on interest: If you have strong credit, you likely will get a loan interest rate that’s lower than the rate on current debts. But note that your total interest costs can rise if the repayment term is extended. You should also avoid shortening the loan term to the point where your new monthly payment is unaffordable.
It’s a scam: Debt consolidation is certainly not a rip off; it’s a credible way to get rid of debt. However, be certain to do your research when seeking a loan. Predatory lenders are out there taking advantage of people struggling with debt.
It’s expensive: While interest rates on debt consolidation loans vary by lender, they are lower than the average rates on credit cards. In fact, for borrowers with excellent credit, such loan rates can start as low as six percent. Since many consolidation loans have no extra fees, the interest is your only cost. Also, lenders hardly ever charge a fee for erasing your debt early. Yes, some lenders may charge an origination fee that pays for loan processing, or minor fees for late payments or processing checks. The loan’s annual percentage rate includes any origination fees, making it simple to compare costs among lenders.
So, now that we’ve vanquished a host of debt consolidation myths, you can seek a loan with confidence and get yourself on track to a better financial future.