You are probably here because you have heard that there is a way you can lump all your debts into a
personal loan and pay it at a
lower rate and within a short period. While this is very true, the process of personal loan debt consolidation is not as straightforward as it may seem and can be counterproductive when not done correctly.
Again, not everyone qualifies for this type of debt management and some people are better off without it. If you are wondering whether consolidating your debt into a personal loan is the best option, keep reading this post.
But first things first, let us learn the basics.
What is Personal Loan Debt Consolidation?
Debt consolidation is a form of refinancing where multiple debts are combined into a new single loan with favorable
payment terms. All
unsecured debts including credit cards and a few types of
secured debts can be consolidated.
Example:
Suppose you have a total of $33,000 in unsecured debt from three credit cards with different balances and loan terms.
Card A has a balance of $9000 at 18% APR payable in 12 months, card B has $14000 at $10% APR payable in 18 months, and card C has $10000 at 16% APR payable in 12 months. You will be paying $825 per month for loan A, $841 per month for loan B and $907 per month for loan C. The total monthly payment for the three loans is $2573.
|
Card A |
Card B |
Card C |
| Balance |
$9000 |
$14000 |
$10000 |
| APR Payable |
18% |
$10% |
16% |
| Months to pay |
12 |
18 |
12 |
| Paying monthly per loan |
$825 |
$841 |
$907 |
| Total monthly payment (A+B+C) |
|
$2573 |
|
Assume that lender XYZ offers to combine all your debts into one personal loan with a 5% APR and 1% loan fees payable in fourteen months. Do the calculations
here, and you will realize that the monthly payments will reduce to $2431. So, the total interest savings will be $1800 (2840 – 1040).
The APR of your current debts are 13.51%. The real APR of your consolidation loan, with fee considered, is 6.63%. So the financial cost of the consolidation loan is over.
This consolidation loan will save you money. After a loan fee of $330.00, you can get $32,670.00 to be used to pay off your remaining debt balance of $33,000.00. So, you will need an additional $330.00 for consolidation.
|
Existing debts |
Consolidation loan |
| Real APR |
13.51% |
6.63% |
| Monthly Pay |
$2,573.00 |
$2,431.47 |
| Payoff Length |
14 months (1 year and 2 months) |
14 months (1 year and 2 months) |
| Loan Fee/Points |
$0 |
$330.00 |
| Upfront Cash Flow for Consolidation |
$0 |
$-330.00 |
| Total Payments |
$35,840.55 |
$34,040.54 |
| Total Interests |
$2,840.59 |
$1,040.54 |
*The calculation of the existing debts assume you pay $2,573.00 per month until paidoff.
Source:
calculator.net.
Now imagine how much you would save if you are lucky to find an offer with a 0% APR and minimal fees. Always ensure that you shop around to determine if there are such offers available and read the fine details to determine if they are what they appear to be.
When is a Personal Loan Debt Consolidation a Good Idea?
In theory, a personal loan debt consolidation is right for you if your debt is not out of control and can be managed within five years. Taking a personal loan for debt consolidation may not be a good idea if you
cannot afford to meet the monthly payments. Before you take this loan, ensure that you have a concrete payment plan. Otherwise, there is a high likelihood that you will find yourself going back to the newly balance free credit cards to fund the personal loan.
You also need to observe your spending behavior to determine if it is in line with the discipline required to manage debts through a personal loan. If you feel that you will be
tempted to take new loans with the balance free credit cards, then perhaps this is not the best option for you. Lastly, this option may not be a good option for you if your credit score is not in good shape.
| A personal loan for debt consolidation is a good idea if you: |
A personal loan for debt consolidation is NOT a good idea if you: |
| Keep your debt under control |
Think it will solve all the debt solutions |
| Have a concrete payment on how to meet the monthly payments |
Hope to spend more by having more room in your budget |
| Are in control of your debt appetite |
Are not in control of your spending behavior |
| Have a credit score of 760 and above |
Finally will be paying higher interest rate |
How to Determine if Personal Loan Debt Consolidation is Right for you
Once you are sure of your preparedness to take a personal loan for debt consolidation, it is time to compare different plans and adopt the most viable. Here are the steps to follow;
- List all your debts on paper.
-
The first step is to list all your debts on a paper. These may include credit cards,
student loans
-
, auto loans, medical bills, etc. Next to each debt, write down the interest rates, the balance, and the total monthly payment.
-
- Determine the monthly payments for each loan.
Identify the minimum monthly payments for each loan and add them together to determine the monthly totals.
- Shop around for offers and use a debt consolidation calculator to determine the most viable ones.
Look for personal loans for debt consolidation offers and use a debt consolidation calculator to determine the most viable rates. Remember to take into account loan fees and other charges when comparing the costs.
Now let’s visually see the situation
Before and
After Debt Consolidation.
Example:
Before Debt Consolidation
| *debt 5%, loan and credit cards 9-28% |
Balance |
Payment |
| Debt |
$180 000 |
$960 |
| Car loan |
$18 000 |
$540 |
| Credit cards |
$15 000 |
$450 |
| Penalty to break debt |
$5 000 |
$0 |
| Total |
$218 000 |
$1 950 |
After Loan Consolidation
| *debt 3.50%, 30 years amortization |
Balance |
Payment |
| Debt |
$218 000 |
$975 |
| Car loan |
Paid off |
$0 |
| Credit cards |
Paid off |
$0 |
| Penalty to break debt |
Paid off |
$0 |
| Total |
$218 000 |
$975 |
The Pros and Cons of Personal Loan Debt Consolidation
Personal loans usually come at a lower rate than credit cards and are therefore the best option when consolidating this type of debt. They also come with fixed terms enabling you to pay off your debt faster. Without the fixed terms, less disciplined borrowers are likely to stay in debt longer since they cannot bring themselves to make payments above the minimum requirement. This means that the debt will end up costing them more than they would with fixed terms.
Another advantage of consolidating debt into a personal loan is that you have only had to keep track of one payment due date instead of several. Again, personal loans, you can lower your monthly payments by extending the payment period for up to three years. On the downside,
debt consolidation, in general, may push you further into debt if you are not disciplined. As mentioned earlier, when you consolidate your credit card debt into a personal loan, you may be tempted to use the newly balance free cards to take another loan.
| Pros |
Cons |
| Lower interest payment |
May push undisciplined spenders further into debt |
| Clear debt faster |
You might not be offered a better rate once you have a spotty credit history |
| Keep track of one payment due date only |
Be aware to choose only trustful online options |
| Lower monthly payments by extending payment period |
|
Bottom Line
To sum up, personal loan debt consolidation is among the best debt management strategies for disciplined borrowers. However, this option is not always as rosy as it appears to be and therefore it is essential that you get all the fine details before you settle on a plan.
