Learn More About Debt Consolidation and How You Can Save Money

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Financial advisors used to recommend that debt payments be paid first, even before the coronavirus epidemic. However, with over 36 million Americans now unemployed the emphasis has shifted towards savings.

It is important to have an emergency savings fund. Experts suggest that you keep at least $1,000 in a high yield savings account to save for unexpected expenses. However, it can be difficult for you to determine which goals are most important if your credit card debt is high and your savings are low.

If you pay your minimum payments on time, your credit rating will be in good standing. Saving money will help to prepare you for unexpected financial situations, such as losing your job, losing income, or being furloughed.

Credit cards, however, have the highest interest rate of all credit products. It is possible to end up paying enormous interest if your current priority is to pay off your credit card balances.

You can consolidate your credit cards debt by using a personal loan via companies like consolidationnow.com, Payoff, or LightStream. It will result in one monthly payment. This will typically result in lower interest and can help to end the debt cycle.

CNBC Select provides a detailed explanation of debt consolidation, its benefits, and how it can help you save money over the long term.

What is debt consolidating?

You may be eligible for a debt consolidation loan if your outstanding debt is on more than one card. This loan is used for the payment of your credit card debt. It then pays off the loan in monthly installments. Usually, this interest rate is lower than what you are paying on your credit cards. Personal loans usually have fixed rates. That means that the APR for the entire loan term is locked in and you will continue to pay the same monthly payments until it’s paid. This is in contrast to credit cards, which may have variable rates that can change.

You can either get a loan from a traditional lender (like a bank) or through an online peer lending company like SoFi, LendingClub, or both. Banks have more than one lender. To get approved for a loan, you must have a satisfactory credit score, good borrowing history, on-time payments, and a sufficient debt-to-income ratio to show you can afford the monthly payments. Peer-to-peer lenders are more flexible or have less stringent requirements. Upstart takes into account your education, job history, and credit score.

How debt consolidation works

Consolidating debt loans are similar to balance transfer cards with a zero percent APR period. However, they work differently. Balancing transfers can be charged fees of between 2% – 5% unless you have opted for a no-fee balance transfer card. Citi(r), Double Cash Card, for instance, charges a fee equal to or greater than 3% of your total balance ($5 minimum). To be eligible for this card, you need good to exceptional credit. However, there are personal loans that can be obtained by people with good or fair credit.

Contrary to a debt transfer, which transfers debt from one account into another, a consolidation loan allows cash to be deposited directly into your account. This cash can then be used to pay off all of the credit card debt. Next, you make monthly payments to your lender according to the timeline you choose when you apply for the loan. Once the personal loan is paid off your credit line is closed.

As with all loans, interest will be charged. The APR of a personal loan may be lower than that of credit cards, which average 16.6% per year, depending on creditworthiness. In general, interest payments are included in your monthly payment and spread over the term of the loan. The most common loan terms run from six months to seven. Your monthly payments will be lower the longer the loan term. However, you will be charged more interest in the long term. It is best to choose the shortest-term loan you are able to afford.

Some lenders charge a signup or origination fee. There are many non-fee options, with different interest rates depending on credit scores. When possible, you should choose a personal loan that is not charged a fee.

A consolidation loan can help you consolidate multiple credit card debts. Because you only have one account, merging your balances into one personal consolidation loan is an effective way to simplify your bill payments.

The most important factor for debt consolidation loans

Although debt consolidation loans are a great way to simplify budgeting, the main factor you should consider when opening one of these is the interest rates. Americans carry $6,194 on average in credit card debt. The average APR is around 16.61%. Assume you could only afford $6,194 in credit cards debt. Pay the minimum amount each month on time so that you don’t pay late fees. You would need to pay this balance for more than 17 years and pay an estimated $7286 in interest fees. (Learn how we came up with these numbers.

Peer-to-peer lending platforms allow you to score a loan for debt consolidation with APRs as low as 4%. According to Fed, the average APR for personal loans is currently 9.63%.

Imagine that you have $10,000 in credit cards debt and a 16.61% interest rate. Experian calculates that interest would cost $2,656.53 if the debt was paid off in three year’s time. For $1,447.90, interest would be paid if you took out personal loans with a 9.63% annual percentage rate. This represents a savings potential of $1,208.63 that could nearly reduce your interest payment by half.

Before applying for any personal loan, it is important to check what APR you qualify for. You will need to enter your social security number and date of birth.

It’s not a guarantee but it can give you an idea of your eligibility for rates. Do not consolidate if the lender offers you the exact same APR (or a lower rate) on your loan than you have with credit cards.

Bottom line

Consolidating debt can help you reduce your spending by allowing you one monthly payment to repay the debt. Converting your credit card debt to an installment loan can help you boost your credit score. It will reduce your credit utilization rate.

You should be aware of the interest rates and fees involved in a consolidation loan. The ideal loan will allow you to reduce your monthly payments while saving you interest.

To avoid credit creep, you should have a plan ready for when your balance reaches $0.

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