Written by: Gilles Hudelot, Director of Education
If you carry debt on multiple accounts or loans, then you have likely considered debt consolidation. Not only can debt consolidation simplify your bills into one monthly payment, but it can also help you save on high interest rates. However, this does not mean that a debt consolidation loan or similar refinancing strategy is the best option for you. There are various factors to consider and you should always do your research before making changes to your debt management strategy.
What Is Debt Consolidation?
Debt consolidation is a form of refinancing that allows you to move or replace your debt with new terms and conditions. The most common option is a debt consolidation loan. This allows you to take out a loan that can be used to pay down existing debts. Ideally, this loan will have a much lower interest rate than your existing accounts.
For example, if you have multiple credit cards with an average APR of 23% and a total balance of $20,000, you could get a debt consolidation loan for the same amount (or more) with a lower interest rate, like 10% to 15%. This way, you can pay off the entirety of your credit card debt and have a single monthly payment that could potentially save you thousands of dollars over the long term.
Is Debt Consolidation Right For You?
While the scenario above may sound great, it does not mean that debt consolidation is the best option for everyone. Before considering a debt consolidation loan or any form of refinancing, you need to do a cost-benefit analysis. Run the numbers and see how much you could realistically save. If the benefits outweigh the costs (fees, interest payments, etc), then debt consolidation will likely be a good option for you.
However, consolidating your debt is not a cure-all for financial burdens. Many people struggle under the weight of debt because of a lack of financial wellness. It is possible that you will need to focus on changing your spending habits and behaviors first. If you continue to spend beyond your means, debt consolidation will not help you manage your debt. In fact, it might just add to your financial troubles.
This is why behavioral changes are so vital when it comes to debt management. One thing to consider before attempting debt consolidation is the debt snowball strategy. With this strategy, you line up all of your debt to understand what you owe and then prioritize the accounts that you want to pay down first. You may want to focus on the smallest balance or the one with the highest interest. Either way, you can use the minimum payment on your other balances while you pay off the highest priority debts quickly.
Factors to Consider Before Debt Consolidation
Debt consolidation or refinancing makes sense if you are in a situation where your current interest rate or payment plan is onerous. A debt consolidation loan can help you ease the burden of debt, with the potential to give you access to even more cash to improve your budget and finances. The same is true of refinancing a mortgage or loan; just be sure to factor in the costs of refinancing and find the break-even point (the point when the savings overtake the initial costs). For example, let’s say you have a mortgage with a 6% APR and you plan to refinance the loan at 4%. However, the cost of refinancing is $2,000. How many months will it take to make up that difference? And will it be worth it to you?
Also, consider how a debt consolidation loan or refinancing will affect your credit score. When you are using debt consolidation to pay off high-interest credit cards, it usually has a positive impact on your credit, as you are transferring debt to a separate loan and lowering the amount of available credit you use. However, this assumes that you will not start building up new balances on your credit cards once you have paid them off. On the other hand, if you do not use all of the loan to pay down debts, you will be adding to your total debt, potentially overextending yourself. This could lead to missed payments, which will definitely hurt your credit score.
If you are weighed down by student debt, you might have four or five federal student loans, which you could consolidate into one private loan. Sometimes the new interest rate will be better, but there might be a difference in the flexibility of repayment options, as a government-backed student loan comes with repayment safety nets, while a private loan does not.
No matter what you choose to do, it is best to be proactive. You should look for the information ahead of time and evaluate your needs, behaviors, and potential benefits beforehand. Don’t wait for credit card loan offers to arrive in the mail; they are often most beneficial to the lender — not you. Instead, do your research and figure out the best solution to meet your needs.
Help Your Workforce Manage Debt With Mentoro
Struggling with debt can hurt an employee’s focus and motivation. Helping them have resources and tools to understand their debt can greatly improve their well-being and work performance. Financial wellness programs are ideal, but you should also consider what kind of educational resources you can offer to your employees. Some 401k providers, financial tax advisors, and corporate-banking institutions provide their own educational resources. You can also explore preferred banking or credit unions for your employees. All of these can be useful in addition to financial wellness programs. Just make sure to communicate these benefits to employees so that they know what they have at their disposal. In doing so, you can help educate your staff and see the benefits of establishing a culture of financial wellness across your organization.
If you want to learn more about managing debt and a debt consolidation loan, or if you are interested in acquiring a financial wellness program for your organization, be sure to contact the experts at Mentoro today!