Debt consolidation has been a hot topic in the past few years. Since the financial meltdown in 2008, banks have tightened up on their risk models and it was near impossible to get a personal loan from a bank. The only realistic way to get a loan was through a HELOC and many Americans were underwater on their homes during this time.
Today, a lot of online lenders have emerged and are changing the way consumers borrow money. Most lenders have a 100% online application that doesn't require branch visits. You can get funds into your account the very next business day and sign contracts entirely online.
With all these perks, it's important to have a full understanding of how debt consolidation works, but more importantly, the common traps to avoid when trying to consolidate your debts.
Acknowledge the Root of the Problem
Debt consolidation is undoubtedly a great way to pay off those high interest rate credit cards and will save you thousands of dollars in interest in the long run. The main benefits of consolidating your debts are single monthly payments and fixed interest rates. Keep in mind that once you pay off your credit cards through a personal loan, you'll have a zero balances on all your accounts. This only means one thing. Access to the credit limits that your credit cards have.
You'll have to be disciplined to make sure you're not accumulating more debt after you paid it off. Spend some time and take a close look to figure out how you got into debt the first place. Was it poor money management skills? Were you spending too much on food, groceries, or travel? Whatever it is, it's important to acknowledge the root of the problem before you apply for a loan.
You're Consolidating the Wrong Debts
When you're applying for a debt consolidation loan, your instinct might tell you to take the highest amount you're approved for. This can actually hurt you in the long run. Take a close hard look to see what your interest rates are with each account.
It might make sense to consolidate all your accounts (even your low interest rate credit cards), but you'll end up paying more interest by doing this. The convenience of having one monthly payment might sound like a brilliant plan today, but make sure you're only consolidating high interest rate accounts. Only take out the amount needed to pay off high interest rate credit cards. You'll be doing yourself a favor by having a lower monthly payment and you'll end up paying less interest in the long run.
Make Sure Lenders are Pulling a Soft Inquiry
One of the last things you want to do is apply for loans with every lender out there. Some lenders will pull a soft inquiry while some will pull a hard inquiry. The main difference is that a soft inquiry doesn't affect your credit score and will only be seen by you. A hard inquiry will be seen by all the lenders and will have an impact on your credit score.
One way to go about this is to use loan comparison engines like ReadyForZero or LendingTree. For example, when using ReadyForZero's debt consolidation tool or LendingTree's personal loan search engine, you'll be able to see live offers from each lenders. The great thing about this is that you can compare interest rates and payments and figure out which option works best for you.
Carefully Review the Contract
The last and perhaps one of the most important steps in getting a debt consolidation loan is to review the terms of the loan. Some lenders may charge origination fees that are taken out of your requested loan amount and others might charge a pre-payment penalty. A great source to read actual reviews of each lender is Credit Karma.
Take a close look at your interest rate, total repayment, and the length of your loan. Next, carefully calculate if the amount comfortably fits within your monthly budget. Some other things to look out for on the loan contract is to see what their policy is for late fees. Are they pretty lenient? Will they forgive late fees in certain cases?
Lastly, you should always check to see what their policy is in changing your due date. We all know life can throw us a curve ball which might impact our ability to pay on certain dates, so having this extra flexibility can go a long way.
When all is said is done, a debt consolidation loan can be a great way to have a fixed monthly payment to get out of debt within a certain time frame. Always make sure you're using common sense before applying for a loan and make sure you're doing it for the right reasons.