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Is Consolidating Debt with a Personal Loan a Good Idea?

How to decide if consolidating debt with a personal loan is good or bad

I’ve been looking at your program, but I am not sure I want to go this route or do it on my own. I’d prefer obtaining a personal loan for $10,000, but I can’t get one for less than 28%, which is a $400 payment that I cannot afford. I’m looking for a payment of around $300.

Candise B. Dallas NC

There are a few key things to consider when deciding if you want to consolidate debt with a personal loan.

#1: Are you getting the benefit of reducing your interest rates?

The main goal of debt consolidation is to reduce or eliminate interest charges applied to your debt. This makes it faster and easier to pay off your balances, because you can focus on paying off the principal, rather than throwing money away on accrued monthly interest charges.

Most credit cards have APR of 18%, but if your credit is bad, those rates could be much higher. However, if you have bad credit, the rates you get on personal loans will also be high, too. In this case, a 28% APR doesn’t sound like it would provide much of a reduction in the interest rate. Thus, you’re not getting the benefit that you’d usually want to see from consolidating debt with a personal loan.

For a debt consolidation loan to be beneficial, it must provide a significant decrease in APR.

#2: Can you comfortably afford the payments?

If you can’t comfortably afford the monthly payments on a debt consolidation loan, then you run the risk of default. In this case, the loan payments won’t work for Candise’s budget. So, even though they may be lower than the total minimum payments on her individual credit cards, they still aren’t low enough to work.

In some cases, you may be able to lower the monthly payment amount on a personal loan by extending the term. Extending the term on a loan means you have more months to repay the loan, which lowers the payments. However, most banks and lenders will only offer terms of 4-5 years (48-60 payments) on a debt consolidation loan. If you can’t extend the term enough to get the payments you need, then a debt consolidation loan is not a wise choice.

If you’re considering a debt consolidation loan, always review your budget to make sure you can afford the payment.

#3: Do you have a Plan B?

Although it’s possible to include unsecured personal loans in a debt management program, the lender must always agree to allow you to include a debt in your program. Even credit card companies must agree to allow your card to be included in the program. However, credit card companies are familiar with DMPs and have standing relationships with credit counseling agencies that run these programs. So, they usually readily agree to allow their cards to be included because these agencies have a proven record of helping their clients rehabilitate their debt.

By contrast, banks and lenders may not have standing relationships with credit counseling agencies. So, while the agency can call the bank or lender to ask that the debt be included, the lender must agree. And some lenders that specialize in debt consolidation loans aren’t always willing to negotiate. They expect you to pay the loan back under the terms set in your loan agreement.

This means you should consider carefully if you’ll be able to successfully repay the loan to get out of debt. If you think you might not reach that goal for any reason, then you may want to consider another option.

Don’t get locked into a debt solution that you aren’t confident will help you become debt-free.

Do you have questions about debt management programs or finding the right solution for debt relief? Ask our certified financial coaches now!

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