How to Consolidate Debt Wisely

We’re about to hit you with a sobering stat so prepare yourselves. The average millennial has $27,251 in non-mortgage consumer debt. Whew. Yikes. How did we get here? Well, that’s a story for another day. The point is that we’ve got lots of debt and it’s time to do something about it.

Let’s start by talking about your options. Defaulting on loans is never a good idea, but consolidating them can be. However, consolidating debt is a personal decision that should be approached with caution. You should consider your specific needs and the type of debt you are carrying before deciding whether or not it’s a good option for you.

If you’re tired of carrying around thousands of dollars in debt then let us walk you through your options. Read on to find out more about what debt consolidation is exactly (definitely not something we learned in school) and how to consolidate debt wisely if it feels right for you.

Wanna skip the chatter and skip straight to learning how to invest in yourself? Download the Wealth Stack app to get started today.

What is Debt Consolidation?

Debt consolidation is a process that involves taking out a new loan that pays off all or most of your outstanding debts, which can include your credit cards, student loans, car loans and mortgages. 

If you’re thinking, “Why would I take on more debt just to pay off my current debt?” then you’re not alone. It’s something that most people don’t understand about consolidation. The idea here is that you’ll repay the new loan over several years at an interest rate that’s much lower than what you are currently paying on these high-interest debt balances. 

You'll also save money on the finance charges because they will only be calculated once instead of being charged each month with multiple payments. When you consolidate debt through this method, your monthly payments might go down by as much as 50% (here’s a helpful debt consolidation calculator). Plus, when you’ve only got one loan to pay off, it makes managing payments just way less of a headache.

What to Consider When Consolidating Debt

First, it's important to understand what types of debts can or cannot be consolidated. Debts like student loans, child support obligations, and taxes cannot currently be consolidated under federal law. However, there may be exceptions, so if you’re not sure, check with your loan provider.

However, other types of consumer debts such as mortgages and car loans can often qualify for consolidation depending on your situation. Let’s say you have a large mortgage loan and a lot of credit card debt and you want to consolidate all of your accounts into one account that has a much lower interest rate. That’s debt consolidation. 

And, in this case, you’d want to follow these steps below to help you make an informed decision about consolidating your debt:

1) Calculate how much interest you're paying on each of your accounts.

2) Figure out what interest rate would be best for one new account.

3) Compare the amount of money you'll save in interest over time with each option.

4) Pick which consolidation method is best for your situation, whether that’s a debt consolidation loan or a new credit card. With this information, and a little research, you'll be able to find a plan that's right for you.

What Are Your Options for Debt Consolidation?

Now, it’s also important to consider your debt consolidation options. The two most popular ways to consolidate debt are through a debt consolidation loan or a balance transfer credit card.

With a debt consolidation loan, you’re essentially taking out a new, larger loan that will allow you to pay off all your debts. Of course, you’ll still be stuck paying off your new loan, but the idea is that, as mentioned above, the loan comes with a lower interest rate so that you end up saving money.

A balance transfer credit card allows you to transfer credit card debt to a new card that has no interest rate, usually for about 12 to 18 months. This gives you time to make payments without accruing interest.

Other options include borrowing against your retirement account or taking out a home equity loan. If you own a home, you can get a loan based on the current equity you’ve got tied up in it. However, this one is a major risk in some caes. It can lead you to lose your home if you start missing lots of payments. And, borrowing against your retirement account can be a risk as well. You'll have less money to enjoy during retirement. But you’ll also risk tax penalties if you can’t make payments.

The Pros & Cons of Consolidating Debt with a Credit Card

Why consolidate debt with a balance transfer credit card? It seems like a risky move. However, here are the benefits: 

  • You can save money on interest rates.
  • There is no need to pay down your entire balance before you start saving on interest. This means more of your payments go towards paying off your principal and less goes to interest.
  • Credit cards offer better protections than personal loans or home equity lines of credit if you have an emergency expense such as medical bills. They provide up to $500 in coverage for eligible charges incurred within 120 days of making the claim (usually much sooner).
  • Because most of these cards offer an introductory period, it can be a great option for those who need more time to save money instead of paying off debt immediately.

However, it’s not the right choice for everyone. Here are a few of the biggest drawbacks of consolidating debt with a balance transfer credit card:

  • The interest rates on credit cards are usually much higher than those on loans and many other types of borrowing.
  • You often have to pay a balance transfer fee. If you have a high balance, this percentage could lead to a hefty fee that makes the transfer not even worth it.
  • Opening a new account and closing your other accounts can hurt your credit score. Your score is ultimately the foundation of your financial health.

What About Debt Consolidation Loans?

Debt consolidation loans allow borrowers with multiple debts to consolidate all their debts into one loan and get a lower monthly payment. One major downside is that this type of loan usually has an extended term of up to 15-30 years. This means that you'll have to pay more in interest over time. 

It’s also important to keep in mind that, as is the case with any loan, debt consolidation loans can come with hefty fees. Take into account loan origination fees, closing costs, and any annual fees and you might find that it’s not worth what you’d save in interest over the years. This all depends on how much debt you owe and what your current interest rate is.

However, the ability to boost your credit and have a fixed repayment schedule are both two big pluses. By following a fixed repayment schedule, your payment and interest rate remain the same for the length of the loan. This allows you to better plan ahead for other areas of your financial life.

How to Consolidate Debt Wisely

Okay, now it’s time to answer the big question: should I consolidate debt? While it’s ultimately a super personal decision that is influenced by a variety of factors, it might be a good option for you if you:

  • Already have a good credit score.
  • You can afford to repay the loan or plan on being able to in the future. This means that you feel like you have a steady job and are planning to continue to increase your income.
  • You like the idea of having one monthly payment instead of multiple payments.

Ultimately, we’d suggest avoiding opening a lot of new credit cards to help pay off loans. It's a slippery slope to go down. We’d also suggest that you start to learn about how to build a solid financial foundation. This starts with learning how to budget, how to improve your credit score, and how to pay bills on time.

If that’s something you struggle with then we suggest downloading Wealth Stack

In the app, you’ll find tons of free financial videos and resources that will help you learn all of this. Once you’ve got a solid foundation to continue to build off of, start interacting with our professional financial Speakers. They can continue to help you grow and compound your wealth.