Tower Loan Blog

Is Debt Consolidation a Good Idea? The Pros and Cons

The debt of American households reached a staggering $14.6 Trillion in 2021. And unfortunately, many of the millions of people with debt struggle with tackling multiple debts at once, with the interest rates preventing them from making any real progress.

Because of that, many people are looking for ways to reduce the interest they have to pay and make a plan for getting their entire debt from multiple sources under control. And that’s where debt consolidation can be an excellent option in some situations.

But is debt consolidation a good idea? And how does debt consolidation work in the first place? Let’s answer these and many other questions below, helping you figure out exactly how to use debt consolidation loans. But first, let’s clearly define it.

What is Debt Consolidation?

Before we can answer the question, “is debt consolidation a good idea,” we must first understand what it is. And in essence, debt consolidation is simply the process of consolidating debts from multiple sources into a single larger debt that can make the process easier to manage.

Having a single payable debt instead of multiple ones is a good idea for many reasons we’ll get into later, but one of the biggest advantages is the ability to potentially work out a more manageable interest rate. This can prevent the numerous debts from increasing despite you making regular payments.

When a person has student debt, medical debt, credit card debt, and a variety of others, they usually have different interest rates and other conditions that can make it challenging to prioritize and work down the debt in a structured manner.

But if you decide, “I need to consolidate my debt,” you will have a single monthly payment instead of multiple and can usually get a more manageable interest rate as well. And those are vital steps in making the debt easier to reduce over time, without worrying about the interest rates keeping the debt high despite your efforts.

How Does Debt Consolidation Work?

Debt consolidation is an excellent way to combine outstanding debts into a single payment and gradually reduce how much you owe. But when figuring out how debt consolidation works, there are a few key steps and considerations you need to think about to make the process more manageable.

First of all, if you’re thinking, “should I consolidate my credit card debt,” you should understand that while it can be worth it, it’s not a miracle solution either. You will need to pay off the entire debt that you owe, and your debt won’t magically disappear if you combine it.

And while the interest rates can be lower, that doesn’t always mean you will pay less overall. Sometimes, even when you get a lower interest rate, which can make the monthly payments more manageable, the debt will have to be spread out over a more extended period. This means the total amount you’ll have to pay can actually become higher.

Therefore, to make an informed decision about consolidating your debt, you should take a few steps before going through the process, which will help you become more informed and better prepared to deal with the situation.

It’s a good idea to schedule a consultation with a certified credit counselor who can evaluate your situation and provide guidance on whether consolidating your debt makes sense in the position you are in.

You should also reach out to the individual creditors before consolidating your debt into a single payment. That way, you might be able to reduce your interest rate beforehand and get an even better solution when you consolidate.

But how do debt consolidation loans work?

There are a few options you could choose from when you decide that debt consolidation is the right choice. Let’s take a look at them.

Balance Transfer

One option is to use a balance transfer card to transfer all your debt onto one card. The biggest advantage of these types of cards is that they usually offer 0% interest for a limited time, which can be very appealing for those who want to get short-term relief from interest as they work down what they owe.

However, it’s important to consider that the 0% interest rate is only temporary and that you will have to pay interest on top of what you owe eventually. What’s more, these types of cards typically have additional fees such as a balance transfer fee or other costs if you were to use the card for purchases.

Before using a balance transfer card, thoroughly analyze the terms and make sure that it makes sense from a financial standpoint for you to transfer. Consolidated debt only makes sense if you actually save money in the process or at least pay less every month.

Personal Loan

You could also consider a personal loan, which is basically a loan given to a person to spend as they wish. Many people take out personal loans for personal expenses, but you could also use them to pay off your other debts and consolidate them into a single payment.

However, just as with a balance transfer card, you should carefully analyze the terms and calculate whether it makes sense. Sure, it’s more convenient to have all of your debt in one place, but you shouldn’t go for that option if it means you will have to pay significantly more through interest and other fees.

Home Equity Loan

Finally, as a last resort, you can consider a home equity line of credit, which requires you to put up your home as collateral for the loan. This type of credit carries a lot of risk on your part because if you fail to make regular payments, you could lose your home.

But at the same time, this type of loan can allow you to get lower interest rates and pay less overall while also having the opportunity to get out of debt faster.

6 Benefits of Debt Consolidation

Consolidating your debt can be a complicated process, but it offers a variety of significant benefits that are helpful when working down your debt.

Let’s explore some of these benefits below.

Simplify Finances

If you’re thinking, “should I consolidate my debt,” one of the main reasons you are probably considering it is that keeping track of multiple debts at once can be a big hassle.

There are multiple due dates that need to be taken care of, various penalties for missing payments, and complex terms of different debts that you need to keep track of.

Consolidating your debt eliminates a lot of the complexity. It allows you to simplify your finances, which means you can focus on actually working down the debt instead of worrying about the various deadlines and other complications.

Repay Debt Sooner

One of the hardest debts to get out of is credit card debt. That’s because it doesn’t have a fixed timeline and usually has big interest rates that make it difficult to get under control.

However, when you consolidate your debt, you can set up fixed monthly payments with a clear end date for the entire loan. This can give your finances more structure and allow you to work down the debt faster, as you know exactly how much you need to pay now and how to speed up the process if you can manage it.

Have a Fixed Repayment Schedule

As mentioned before, having a fixed and structured repayment schedule can make a huge difference in your chances of working down the debt.

When answering the question, “is a debt consolidation loan a good idea,” having a fixed schedule and a fixed amount you have to pay rank high as reasons why many people opt for this route, even if the savings on interest aren’t always in their favor.

May Reduce Monthly Payment

While many advantages of debt consolidation center around stability and a fixed payment plan, it can also help reduce the monthly amount you have to pay.

Even if the overall amount remains higher, you may be able to get a lower monthly payment simply because the total sum is spread out over a more extended period.

Get Lower Interest Rates

At the same time, you can also expect the interest rates to become more manageable when you go for debt consolidation, especially if you manage to improve your credit score by the time you decide to consolidate your debt into a single payment.

If that’s the case, you could get a better interest rate and reduce how much you must pay, especially if you don’t consolidate with a very long loan term.

Boost Credit

A big part of managing your debt is gradually improving your credit score to get better interest rates. Consolidating your debt can eventually improve your credit score by reducing credit card debt, making consistent payments on time, and reducing the overall amount you owe.

However, keep in mind that the hard credit inquiry that comes with a new loan can lower your credit score temporarily.

4 Drawbacks of Debt Consolidation

Now that we’ve looked at some of the main advantages of debt consolidation, it’s important also to consider the drawbacks so that you can make an informed decision and answer the question — is it good to consolidate debt?

Let’s look at a few of the main drawbacks below.

You May Pay More Interest Over Time

As mentioned before, even though debt consolidation can make monthly payments more manageable, the interest rate you have to pay can actually be higher.

That’s because it usually depends on the type of consolidation method you use and your current credit score, which might not always be favorable, especially after a hard credit inquiry.

At the same time, even if you get a better interest rate, spreading the loan out over a longer period can also increase the overall amount you will need to pay if you don’t return the debt ahead of schedule.

There May Be Upfront Costs

Consolidating your debt is, in essence, taking out a new loan. That means it can come with additional fees and up-front costs that can play a role in whether it makes sense in your situation.

Some of these include balance transfer fees, closing costs, various annual fees, and loan origination fees. So when looking at debt consolidation options, make sure to read the fine print and find out the interest rate and the fees you will need to pay.

You Risk Missing Payments

When consolidating debt, you can add structure to your repayment plan and have a single payment instead of multiple debts to manage. But you still need to carefully evaluate whether you can comfortably pay the monthly payments, as missing even a single payment could result in various penalties and damage your credit score.

You should leave some room for the amount of minimum payment you need to make, as it’s always better to pay more than the minimum and work down your debt ahead of schedule.

May Encourage Increased Spending

While debt consolidation can be incredibly effective, the potential for more control over your finances can also create new challenges you’ll need to overcome. Namely, as you become more comfortable with managing your debt and feel like you have it under control, you may become tempted to take out more debt or increase your spending.

To ensure that your debt repayment plan succeeds and that you work down your debt, try to repay as much as you can and keep your spending down as much as possible.

Is Debt Consolidation a Good Idea?

Debt consolidation is an interesting alternative to paying separate loans. And at this point, it’s time to tackle the main question — are debt consolidation loans a good idea? While the answer isn’t as straightforward as some may think, there are situations where it can be an effective way to take control of your finances and avoid having to fight a losing battle with rising interest.

Before deciding, however, you need to answer a few critical questions about your situation.

First, consider whether you are mentally and financially prepared to make a regular single payment and make a conscious effort to work down (and eventually eliminate) your debt. That will require sacrifices and the ability to cut spending, so map out a plan you would follow before you make a decision.

Debt consolidation can help you manage your payments better, as a single payment plan with a precise loan end date is something that is much easier to plan for.

If your current finances allow you to cover the debt at all, you should definitely consider this option. However, the type of debt consolidation loan you get will mostly depend on your credit score. In some cases, you might not be able to get a loan at all until you improve your credit score.

Even if you can get a debt consolidation loan, you should still carefully evaluate whether the interest rates aren’t too high for you to manage right now. You may find that you would be better off working on your credit score with the different types of debt you currently have and then getting a consolidation loan at a better interest rate.

Finally, if the amount of debt you currently have isn’t that big to begin with, perhaps it would make more sense to simply attack the debt without consolidating it and try to eliminate it altogether.

Bottom Line

At this point, you should have a pretty solid answer to the question, “is debt consolidation worth it,” especially if you evaluate your own situation and look at what going with this option would mean for your finances.

If you would like to learn more about the possibilities of consolidating your debt with Tower Loan, our consultants are there to help. Call your local office today or visit our website, and our team will guide you through the entire process, answering any questions you might have.