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When you consolidate your credit card debt, you are getting a new loan. You have to pay the new loan just like any other loan. If you get a consolidation loan and keep making more purchases with credit, you probably won’t succeed with paying off your debt. If you have credit problems, consider contacting a credit counselor first.
Consolidation means that your various debts, whether credit card accounts or loan payments are grouped into a single monthly payment amount.
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Before using a credit card consolidation loan,
- Take a look at your expenses. It is important to understand why you have debts. If you have accumulated many debts because you are spending more than you earn, a debt consolidation loan is probably not going to help you get out of those debts, unless you reduce your expenses or increase your income.
- Make a budget Find out if you can pay your existing debt by adjusting the way you spend, for a period of time.
- Try to contact your individual creditors to see if they would agree to reduce your payments. Some creditors may be willing to accept lower minimum monthly payments, avoid certain charges, reduce your interest rate or change your payment date to better match your income, to help you pay off your debt.
Transfers of credit card balances (Balance Transfer)
Many credit card companies offer balance transfers with a zero percent interest or a very low interest to invite you to consolidate your debts into a single credit card.
What you should know:
- The promotional interest rate for most balance transfers lasts for a limited time. After that, the interest rate on your new credit card may increase, which would increase the amount of your payment.
- If you are late with more than 60 days in payment, the credit card company can increase the interest rate on all your balances, including the balance you have transferred.
- You will probably have to pay a “balance transfer fee”. The charge is generally a certain percentage of the amount you transfer or a fixed charge, whichever is greater.
- If you use the same credit card to make purchases, you will not get a grace period for those purchases and you will also have to pay interest until you pay the entire balance in full (including the transferred balance).
If you decide to make a credit card balance transfer, avoid using that card for other purchases, at least until you have paid the transferred balance. That will help you pay the balance more quickly and avoid paying interest on other purchases.
Debt Consolidation Loan
Banks, credit unions, and installment loan lenders offer loans for debt consolidation. These loans accumulate many of your debts in a single loan payment. This simplifies the number of payments you have to make. These offers may also include lower interest rates than you currently pay.
What you should know:
- Many of the low-interest rates for debt consolidation loans can be “introductory rates” that only last for a certain period of time. After that, the lender can increase the rate he has to pay.
- The loan may also include charges or costs that you would not have to pay if you continue to make your other payments.
- If your monthly payment is less, it could be because you are paying over a longer period of time. This means that you will end up paying much more in total.
If you are considering a debt consolidation loan, compare the loan terms and interest rates to see how much interest and charges you will have to pay in total. This can help you choose the loan that will save you the most money.
Loans on the net value of the home (Home Equity Loan)
With a loan on the net worth of the home, you get a loan against the net worth of your home. If you use it to consolidate debts, you use that loan to pay in full to existing creditors. Then, you have to pay the loan on the net value of the home.
What you should know:
- A home equity loan, using the net value of your home, to consolidate credit card debts, is risky. If you do not pay the loan, you could lose your home under foreclosure.
- Loans on the net value of the home may offer lower interest than other types of loans.
- With a loan on the net worth of the house, you may have to pay closing costs. Closing costs can cost hundreds or thousands of dollars.
- If you use the net worth or capital of your home to consolidate your credit card debts, it may not be available in case of an emergency or certain expenses such as repairs or renovations.
- By using your net capital for a loan, your home could be “devalued” if the value of the loan falls. This could make selling or refinancing harder.
If you want to consolidate your debt, there are some things you should think about:
- By assuming a new debt to pay off old debt, you would simply be putting off your problems. Most people fail to pay their debts by taking on more debts unless they lower their expenses.
- The loans you get to consolidate your debts may end up costing you more in expenses, charges, and higher interest rates, than if you had made your previous debt payments.
- If the problems with the debts have affected your credit score, you will probably not be able to get low-interest rates for the balance transfer, or for a consolidation loan, or for net worth loans.
- A nonprofit credit counselor can help you compare your options and decide how you want to use the credit in the future so that the problems that have led you to consider consolidating your debts do not come back later.