Debt consolidation is one solution to consumer debt, and it works by providing a new loan to cover existing debt. While it helps many people get back on track financially, debt consolidation is not for everyone. The following are a few things to consider before trying this approach to getting out of debt.
Check Credit Score
Since debt consolidation requires applying for a new loan, the borrower has to have a credit score that is acceptable to the lender. On average, a score of 620 is on the low end for this type of loan; however, some lenders will make higher-interest loans to customers with a lower score. Consumers can find out their credit score by requesting a free report from each of the three main credit reporting agencies.
Decide Which Debts To Consolidate
Before applying for a debt consolidation loan, it’s important to make a debt inventory, listing all debt amounts and interest rates. In general, consumers need to get rid of their debt with the highest interest rate first. For lower-interest debt, it might be worthwhile to keep making those payments or request an extension from the lender, especially if the interest rate is lower than that of the new loan.
Consider Types Of Debt
Even though debt consolidation loans are a good way to get rid of high-interest debts by rolling them into a single payment, they are not a good solution for certain types of debt. For example, mortgages and home equity loans cannot be consolidated, nor can auto loans, student loans, or back taxes owed to the IRS.
Consider Cash Flow
Another important point consumers should consider before applying for a debt consolidation loan is whether or not their cash flow will cover loan repayments. Experts advise keeping total debt payments at less than 50% of income and making sure there is sufficient cash flow to cover payments every month. In addition, borrowers are much more likely to be successful if they have a plan in place to avoid going back into debt once they pay off current loans.
Debtors who owe more than 50% of their income have other options, such as debt relief or even bankruptcy. To learn more about paying off debt, click here.