If you’re struggling with credit card debt, you’re not alone. According to Experian, one of the three major credit reporting agencies, the average American has a credit card balance of $6,028, as of 2019.
Credit cards tend to have very high interest rates. In fact, the Federal Reserve reported that the average APR is 17.14%. With such a high rate, your credit card balance can quickly balloon out of control, causing you to owe far more than you originally charged.
If you’re determined to pay off your debt as quickly as possible, taking out a debt consolidation loan can make a lot of sense. Here’s what you need to know about the pros and cons of this strategy.
What is a debt consolidation loan?
A debt consolidation loan is a personal loan you take out for the amount of credit card debt you currently have. For example, if you had one credit card with a balance of $10,000, and a second card with a balance of $5,000, you would take out a personal loan for $15,000 and use it to pay off those credit cards. Going forward, you’d have just one loan and one monthly payment to remember.
Benefits of debt consolidation loans
Taking out a debt consolidation loan can be a smart way to tackle your credit card balances because of the following benefits:
1. You can save money
With a debt consolidation loan, you can qualify for a loan with a much lower interest rate than you have on your credit cards. With a lower rate, you can pay off your debt much faster, and save money over the length of your repayment.
For example, let’s say you had $15,000 in credit card debt at 17.14% interest. Your monthly minimum payment would be $450 per month. If you only paid the minimum, it would take you nearly four years to repay your debt. And, you’d repay a total of $20,250. Interest charges would cost you a whopping $5,250.
If you consolidated your debt and qualified for a loan with a 6% interest rate and a three-year loan term, your monthly payment would be $456. But, you’d repay just $16,428 over the length of your loan. By consolidating your debt, you’d save over $3,800 and be out of debt nearly a year earlier.
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2. You’ll have a set repayment date
When you take out a personal loan, you can choose a repayment term. Most lenders offer terms from two years to seven years in length. Once you are approved for the loan and the money is disbursed, you’ll know exactly when you’re scheduled to make your last payment.
Being able to circle a date on the calendar that indicates when you’ll be debt-free can be a tremendous motivator and give you much-needed relief.
3. You can boost your credit score
When you pay off your credit card balances, you’ll reduce your credit utilization —a big factor in determining your credit score. Even though you still owe the money, taking out a debt consolidation loan to pay off your credit card balances can boost your credit.
Drawbacks to debt consolidation loans
Debt consolidation loans can be useful, but there are some drawbacks to remember:
1. Debt consolidation doesn’t fix the problem
Using a debt consolidation loan to pay off your credit cards doesn’t fix the problem or address the root causes of your debt. If you’re not careful, it could actually worsen the problem, and you could end up right back where you started.
Before taking out a loan, make sure you review your finances, come up with a budget, and identify a repayment plan to pay off your debt.
2. You’ll need good credit to qualify for low-interest loans
While personal loans can have low interest rates, you’ll need to have good to excellent credit to qualify for a low-interest loan. If your credit is only fair or even poor, you may not be eligible for a low interest rate, making it impossible to use a debt consolidation loan to tackle your credit card balances.
Managing your debt
In some cases, using a debt consolidation loan can be a smart way to manage your credit card debt. If you decide that this strategy is right for you, make sure you get quotes from multiple personal loan lenders to ensure you get the lowest rates available.
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