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Consolidating debt means grouping debts under one umbrella at a good interest rate. When should you consider consolidating your debt? In this article and the GOBankingRates infographic below, we share some common scenarios where it makes sense to consolidate your bills.
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Let’s take a look at the debts that may be eligible for consolidation and the next steps to take once you’ve decided to consolidate your debts.
When you have multiple student loans
If you have multiple student loans, you may want to refinance your student debt or consolidate debt if you don’t qualify for refinancing. Student debt consolidation combines all your existing loans into one loan and at a new interest rate that is the weighted average of your previous loans. This allows borrowers to simplify their cash flow and payment process.
Before consolidating student loans, however, it is important to keep the following aspects in mind. First, borrowers can only consolidate federal student loans. Private loans are not eligible for consolidation. Second, a new interest rate per consolidation does not change your interest rate. What it does is average all your fares, which can make it easier to manage payments.
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When you have a large debt
Large debts often include credit cards. Francis Collins SVP, credit at Federal Credit Union Teachers, said debt consolidation is ideal for people who have multiple credit card debts. Large credit card debt includes high balances and high interest rates.
Barry Rafferty – senior vice president and head of capital markets at Freedom Financial Asset Management, the asset management and lending arm of Liberty Financial Network — said consolidation can be a great idea if you have multiple credit card accounts and are in debt on those accounts with high interest rates.
“A lot of people struggle with juggling payment dates and making sure they make every payment on time every month,” Rafferty said. “Working with a debt consolidation loan eliminates the risk of late payments and mounting interest on many different bills, as well as the stress of trying to manage it all.”
When you have multiple high interest loans
Similar to student loans and credit cards, if you’re struggling with other types of high-interest loans or have “sore” debt, you can explore the best debt consolidation option to save on interest and repay the debt.
Next steps for debt consolidation
Once you know you are ready to consolidate your debt or have any of the above debts eligible for debt consolidation, Rafferty recommends taking the following steps.
Understand your debt situation
Before you start looking at debt consolidation methods, Rafferty said the first step is to understand your particular debt situation. Beyond organizing your current debts and checking your repayment capacity, you should be able to deal with the real problem behind the need to consolidate your debts.
“Most people find that working to consolidate and eliminate their debt means changing some habits and getting serious about the payment plan,” Rafferty said. If you’ve ever lived beyond your means, now is the time to create and stick to a budget.
Choose the best debt consolidation loan
Although there are several consolidation options available, such as home equity loans or a cash refinance, most individuals consolidate their debts with a consolidation loan. Use this time to research the best deal and find a lender you can communicate well with.
“Many potential borrowers benefit from working with a lender who has loan consultants who will work with them to determine the best terms and rates, and who can take the time to understand their credit situation, as well as other factors that indicate that they are fiscally responsible,” Rafferty said.
When looking for the best consolidation loan, find out about the discounts available. Rafferty uses the example that some lenders have rate reductions when there is a strong co-borrower or when retirement savings have reached a certain level.
Prepare your credit profile
Interest rates are highly dependent on credit scores, which is why Rafferty recommends applying for a consolidation loan with the best possible credit profile. (Some lenders may require a certain number of years of credit history before you can apply.)
“In most cases, higher credit scores lead to lower interest rates,” Rafferty said. There are cases where lenders will still be able to lend consolidation loans to consumers with bad credit, but the caveat is a much higher interest rate.
It is also useful to know your debt-to-income ratio. Rafferty said many lenders will require it to be below 40%.
Fill out the application
Once you have the best consolidation loan deal for your debt, the next step is to complete the application and pay off the debts.
Once the debts are paid off, you will have more financial leeway to repay the loan and straighten out your financial situation to get back on track to achieve financial freedom.
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