16/11/2022
What Is Debt Consolidation and Is It a Good Idea?
There are multiple ways you can handle your debt, and one of the most effective ways is with a debt consolidation loan. Is debt consolidation a good idea for you? Let’s break down debt consolidation to find out if it’s the right fit for you.
What is debt consolidation?
The meaning of debt consolidation is bringing together your multiple types of debt obligations (liabilities) into a single payment.
Basically, debt consolidation means taking out one big loan to pay off multiple smaller loans or outstanding bills. The big loan repays all your debts to your creditors at once leaving you with one monthly payment, usually with a lower interest rate.
We know, it sounds a bit counterintuitive to take out a whole new loan to pay off other loans. The truth is that debt consolidation doesn’t make sense all the time—the idea is to get a significantly lower interest rate. If that doesn’t happen, there’s no point in going for it. Moreover, it’s important to note that debt consolidation doesn’t mean debt relief, but rather a simpler, more favorable way to pay down your current debt.
The benefits of debt consolidation are worth it if you get lower interest, especially if you have a good to excellent credit score. Let’s dive deeper into that.
How does debt consolidation work exactly?
Let’s meet John.
Every month, upon getting his salary, John has to think about his debt. He has multiple debts:
Student loan
Credit card balance
Car loan
John didn’t start off with the best credit score, but he has been paying his dues on time and his credit score is now 690, which is above average in Canada. Thinking about how to get smarter with his finances, he decides he needs to look into getting a lower interest rate.
Educated on the idea of debt consolidation, he calculated the new rate he could be paying if he went for it.
Let’s say John has $20,000 in outstanding credit card debt and is paying an interest rate of 19.99%. He consolidates his loan with a personal loan at 10.99%. John could save up to $95/month over his 5 year term.
Does Debt Consolidation hurt your credit score?
Consolidating multiple accounts into one loan can lower your credit utilization ratio, which can lower your credit score. However, getting a personal loan to cover your debt will not impact your credit score and can save you money on lower interest rates.
