Figuring out how to pay down debt is hard enough already. But when you consider the fact that many Americans are trying to manage multiple balances from different lenders, it gets that much more complicated. It’s all too easy for payments to start slipping through the cracks when you feel overwhelmed by how complicated it is to simply make monthly payments on what you owe.
Debt consolidation, specifically through a loan, is designed to simplify that process by streamlining it down into one single payment each month. But there are a few important things to understand about consolidation before running to the nearest bank, credit union or online lender.
Keep reading to learn more about all things debt consolidation, particularly about what you can expect from the annual percentage rate (APR) on a loan and how to maximize your chances of success using this strategy.
How Debt Consolidation Works
First of all, it’s important to understand that you’re substituting current debt for different debt — something that can either help or hurt your situation, depending on how you handle it.
Debt consolidation involves taking out a loan and using it to pay off other unsecured debts like credit cards and medical bills. Not only does this alleviate the need to keep up with so many payments each month, but it can also save you money in the long run if you end up paying less in interest on the loan than you would on your current lineup of debts.
There are a few caveats to keep in mind, namely that getting approved for a competitive consolidation loan typically requires a good-to-excellent credit score, strong payment history and proof of sufficient income.
Compare the ARP: Debt Consolidation vs. Credit Cards
The primary factor determining whether debt consolidation is a solid option for you comes down to how much you’ll be able to save in interest. The only way to figure this out before actually taking on a loan is calculating how much you’ll pay given the APR you qualify for and the loan length.
According to ValuePenguin, the average APR for a consolidation loan is around 18.56 percent — but that average can actually range anywhere from about 8.31 percent all the way up to 28.81 percent. The exact rate you’re able to secure will depend on the lender and your credit background, among other things. Having an excellent credit score of 720 or above can help you secure rates under 5 percent; having poor credit under 640 tends to correlate with double-digit APRs up to 30 percent.
Now contrast these consolidation APRs with the average APR on credit card purchases, which is currently around 21.40 percent according to The Balance. Credit card APRs can go as high as 29.99 percent. Store credit cards in particular tend to carry rates north of 25 percent.
Crunching the numbers, you may find a consolidation loan will be cheaper to repay in the long run — not to mention simpler because you’ll only be responsible for that one payment rather than a wallet full of credit cards and/or a desk full of medical bills each with different due dates and interest rates.
When you’re calculating the total cost of a consolidation loan vs. what you’d pay with do-it-yourself debt elimination, don’t forget to factor in the length of your loan. As the experts at MarketWatch advise, your total interest costs can actually increase if you extend the repayment term. Always look at the total cost rather than monthly cost when deciding whether or not to consolidate.
Debt consolidation loans have average lower APRs than credit card balances and can be simpler to repay. These are compelling reasons to consider applying — just do your due diligence first.