Debt consolidation is the process of merging several high-interest debts into one monthly payment. This is helpful for people struggling to make their minimum monthly payments due to high-interest rates. However, debt consolidation is not right for everyone. Read on to find out if it's right for your financial situation or if you’re better suited for an alternative.
Methods of Debt Consolidation
There are several methods of debt consolidation and the main differences are based on your credit. You may not be eligible for a balance transfer credit card or personal loan that meets your debt requirements if your credit is poor. No matter what method you decide on, you will have to change your spending habits. Your financial habits enabled you to rack up multiple forms of debt, but if you are seeking information on debt consolidation you probably want to improve your finances. So you should keep in mind the habits that got you into this situation so you can address them - the last thing you want is to pay off your debt and then start racking up more balances.
Balance Transfer Credit Card
Many credit cards have an introductory 0% APR offer for a limited time, usually ranging from 6 months to 1 year. You can transfer your credit card or loan balances from your current credit cards to a card with this promotional offer. Be aware that you will probably have to pay a balance transfer fee for each balance, so you should look into this before applying for the card. Depending on the credit card you plan to transfer the balances to, you may only be able to transfer a percentage of your credit limit. For instance if the policy says you may transfer up to 75% of your credit limit and let’s say that’s $10,000 then you can only transfer $7,500. You'll have to look into the fine print before applying for any balance transfer credit cards to be aware of the balance transfer limit and fees. The idea is that you’ll pay off most of the balance before the promotional period ends because after the 0% APR period the interest rate will likely increase dramatically.
Another option is to get a personal loan or a debt consolidation loan and use those funds to pay off each debt you may have. This makes sense if you are able to get a loan with a significantly lower interest rate than your current lines of credit. Otherwise, you are better off with one of the alternatives detailed below. It may be difficult to get approved for a low interest rate loan with the limit required to transfer all of your debts. Be sure to calculate the total balance of all your debts and make sure the loan is up to that amount before applying.
Debt Consolidation Services
There are countless companies that specialize in debt consolidation or debt management. We recommend this option only if you don’t think you can utilize one of the alternative methods discussed below and if you don’t qualify for a balance transfer credit card or personal loan. With this method, the company will negotiate with your creditors in order to get you a lower interest rate and lower monthly payments. Then you will pay the debt consolidation company each month and they will disburse your payments to each creditor. Obviously your monthly payment will also include a payment to the debt consolidation company because they have to make money too.
Alternatives: Avalanche & Snowball Debt Methods
All of the previously discussed debt consolidation methods require you to open a new line of credit (balance transfer card or personal or debt consolidation loan) or pay a debt consolidation company to assist you. If you have made the decision to pay off your debt and achieve financial freedom, then you may be able to use your new commitment and motivation to manage your debt and pay it off on your own. Read on to find out a couple of methods to do this.
Snowball Debt Method
Both of these methods only work if you pay the monthly minimum payment for each debt and you have money available to allocate after that. You may have to cut expenses in order to do this or find ways to make more money. To find out ways to cut costs, read 9 Ways You're Losing Money Without Even Realizing It.
The snowball debt method works by paying off each debt from the smallest to the largest balance. As you pay off one debt, you move on to the one with the next smallest balance. This allows you to build confidence and motivation to pay off all of your debt by knocking out the small ones first. The downside of this method is that while you are paying off these smaller debts the other balances are accruing interest. The avalanche debt method discussed below helps to minimize the amount of interest that you’ll accumulate while paying off your debts.
Avalanche Debt Method
To use this method, you will have to organize your debts by interest rate, highest to lowest. After paying each monthly minimum payment, any additional money you can use goes toward the debt with the highest interest rate. After paying off that debt, you move on to the one with the next highest interest rate and pay off each one until you are debt free. Compared to the snowball debt method, this method will save you money on interest that accrues while you are paying off your debts.
To learn more about the avalanche and snowball debt methods, read Paying Off Debt: Snowball vs Avalanche Methods.
Whichever debt consolidation method or alternative you decide on, pat yourself on the back for taking the first step toward financial freedom. Remember to adjust your spending habits and cut costs so that you don’t accumulate additional debt during this process. Now keep your eye on the finish line because it will take dedication to pay off your debts and reach the goal of being debt free. But, you can do it!
Financial freedom begins with good habits!
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