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Debt consolidation, as the name suggests, is a debt solution that will allow you to combine your multiple debts into one simple payment plan. This is meant to make your payments easier. Instead of monitoring various debts and making sure that you meet the minimum payments and the due dates at different times of the month, all of these will be consolidated into one.
There are various ways that you can consolidate debt. You can transfer your balance into a new credit card that offers a zero or very low-interest rate. You can borrow a loan that will help you pay off your multiple debts so you are left with one huge debt. Of course, you also have the option to hire a credit counselor who will help you negotiate your debt payments. They will help you create a repayment plan that you can afford and have it approved by your lenders and creditors. If everything goes well, you will send one monthly payment to them and they will make sure it is received by your different creditors.
All of these options are effective means to consolidate debt. The challenge here is determining - which is the perfect solution for your unique financial situation.
Before you call the #1 Debt Consolidation Company to start working on your debts, you need to be aware of the 5 steps that will make your consolidation efforts easy and effective.
Step 1: Know your debt situation before you consolidate debt
The first step to an easy and effective debt consolidation is to understand your unique debt situation before you do anything else. After all, you need to know the problem thoroughly before you can hope to solve it. How can you choose the right solution if you do not have the complete understanding of; what are you trying to solve?
There are a couple of things that you need to pay attention to when you are analyzing your debt situation.
- Your balance. This is probably the most important one - how much do you really owe? Take note that your current balance is usually influenced by a lot of things - like interest rates. For instance, your credit card balance will increase if you failed to pay it in full by the end of a billing cycle. This is why you need to constantly check your balance to make sure that it is current. Otherwise, your computations are plans may not be accurate.
- Your interest rates. This is the most influential part of your debt. It can dictate how fast your balance will grow over the repayment period. If you will consolidate your debts, you should get the average interest rate of your multiple debts. That way, you will know the interest rate that you should target when you consolidate your credit accounts.
- Your due dates. Some people stop paying their debts as soon as they decide to consolidate it. This is a wrong move. You need to continue meeting your payments until your consolidation strategy is approved. Otherwise, you will incur late penalty fees and that can compromise the balance that you currently owe. Unless you get confirmation that the consolidation is pushing through, continue meeting your payment obligations with your original creditors and lenders.
- Your credit terms. Finally, you need to take note of the terms of your credit accounts. You need to find out if there are any prepayment penalties in your account. That can be a problem when you consolidate your debt. The consolidation will involve paying all your multiple debts through the loan or new account that you will open. That means you will be charged with a prepayment penalty - if it is applicable.
Once you have a clear understanding of your debts, you can now proceed to the next step.
Step 2: Find out how much you can afford to pay on the consolidated debt
Before you can start solving the problem, you have to understand your capabilities to solve it first. That means you need to get to know your financial position before you decide on a solution. For instance, you may think that debt consolidation is the answer but if your income cannot afford to pay all your debts, then what you may need is a debt reduction.
There are a few things that you need to look into when you are scrutinizing your finances.
- Your income. Start with your income because this is where you will get the funds to pay off your debts. You need to get the total amount of what you really earn each month. If you are earning an irregular income, you have to base your calculations on the lowest income that you earn. When you base it on the highest, you might fall short.
- Your expenses. After looking at your income, you need to check all your expenses. Take out all the debt payments because that will be consolidated later on. You need to get only the expenses that you need to survive. Make sure that you allot a budget for your entertainment expenses because you also have to spend some money on fun activities. Otherwise, you might feel that your budget will be very restricting. Be realistic and practical when you choose the expenses that you have listed down. Once it is complete, you can deduct the expenses from your income to determine your disposable income. This is the amount that you can use to pay off your debts.
- Your source of income. After calculating your disposable income, you should take a look at your source of finances first. You want to make sure that this source is stable and steady. If there is a chance that your source of income can be compromised in the future, that will influence how much of your disposable income you will allocate towards your debt payments. If your income is not stable, you need to allocate only 70% of your disposable money. The rest should be put aside for the times when you feel like your income cannot support all the expenses and debt payments that you have to pay each month.
- Your emergency fund. Finally, you have to take a look at your emergency fund. If you do not have this fund, you need to avoid committing most of your disposable income to your debt payments. You need to give this fund a boost first. This reserve fund will help you out of tight financial spots in the future and will keep you from compromising your debt payments.
While you are encouraged to pay as much as you can towards your debts, do not commit 100% of your disposable income towards your debt payments. You may want to allocate a lower percentage so you have a buffer left on your budget.
Step 3: Identify your financial goals after consolidating debt
Once you have studied both your debts and financial situation, it is now time to identify your financial goals. Some of your expenses might give you an idea about what these goals are.
The reason why you need to think about your goals is because you want to make sure it will not be compromised after you have consolidated your debts. You see, most of the options to consolidate debt will have an effect on your score. For instance, debt consolidation loan, after the hard inquiry and the loan approval will make your credit score go down. While this is only temporary, it might affect your chances of getting a loan in the near future.
And if you had been saving up for a vacation this holiday and you plan to use your credit cards during your trip, you might want to postpone enrolling in a debt management program for now. When you enter this program, your credit cards will be frozen until you finish paying off your balance. This might be a problem when you travel.
These are only some of the scenarios that you will encounter if you fail to take into consideration your financial goals when you choose among your debt consolidation options.
Step 4: Research your options to consolidate credit
After all the information that you have taken about your finances, it is now time for you to choose from the different options to consolidate debt. Everything that you have analyzed so far will help you make a smart choice. For instance, if you know that you need to access your credit cards in the next few months, you should avoid choosing debt management.
To make your choice, here are your options to consolidate multiple debts.
- Debt Consolidation Loan. This involves an unsecured loan that you will borrow to completely pay off your multiple debts. If you have 4 debts with a total balance of $10,000, you will borrow a loan that equals this amount. Once approved, the new lender will pay off the 4 debts and then you will be left with only one debt. You will not concentrate on this single debt until you have completely paid it off. To make this even more beneficial, you may want to make sure that you can borrow this loan with the lowest interest rate possible. To make this happen, you should have a good credit score.
- Home Equity Loan. If you own your home and you want to get rid of high-interest credit card debt, using the equity in your home is a great way to consolidate. Since this will be a secured loan, you can expect a low interest on your loan. Of course, you have to make sure that you can pay everything off because if you fail, you can lose your home.
- Balance transfer. This option involves a new credit card that is offered with a 0% interest rate. Some credit cards are offered with a very low-interest rate. Credit card companies use this introductory promo as a way to encourage consumers to open a new account with them. You can transfer your balance to this new card. You have to pay a balance transfer fee that is usually a percentage of the debts you will transfer. It is important for you to have a plan to pay this off because the 0% or low-interest rate is only temporary. After a few months, it will soon be over and the card will have a higher interest rate. But while it is within the introductory rate, make sure that you will maximize your monthly payments because most of it will be credited towards the principal balance.
- Debt Management. This is the only debt consolidation option that involves a debt expert. You will be assigned a credit counselor who will help you create a Debt Management Plan. This plan will contain a new repayment plan that suits your specific financial situation. The counselor will help present this to your different creditors and lenders. Once approved, you will get the total monthly payment for all your credit accounts and you will send it to the credit counselor. They will be responsible for disbursing the debt to the different creditors and lenders in the plan. You just have to make sure that you will put your trust in the right company. You may want to read well researched debt consolidation reviews so you can make a smart choice about your debts.
Step 5: Check which debt consolidation option you qualify for
For the final step, you will now decide on the consolidation strategy that you will use. With all the information that you got about your debt, finances, goals, and option, you should be able to choose the right solution for your credit situation.
When choosing the perfect way to consolidate debt, you need to ask yourself the following questions.
- What type of debts do you owe? There are certain debts that are hard to consolidate. Those that has a prepayment penalty is one of them. Unless the savings that you will get in consolidating is much more than the prepayment penalty, it is advisable that you avoid paying this. You should also consider the average interest rate that you owe. If the interest will be bigger when you consolidate, then you should probably reconsider the low-interest debts that you owe.
- How much can you afford to pay each month? This will help you narrow your options. If you have a stable job and you know that you can pay a lot on your principal balance for the next few months, then balance transfer is the right option for you. This consolidation strategy will require you to aggressively pay your debt while the card still has a low or zero percent interest rate. But if you cannot do that and you want a lower monthly payment, then debt consolidation loan or debt management is the better option.
- What are your financial goals? If you intend to use your credit cards, you should avoid debt management because it will freeze your accounts until you complete the debt management plan. You might be better off with balance transfer or debt consolidation loans. If you want a good credit score, then you should choose the consolidation strategy that will have the least effect on your credit rating.
Once you have answered these questions, you cannot choose which of your options suit your financial position best. It is also very important to take your personal preferences into consideration. If you are a very busy person and you have a hard time keeping up with your payments, then use debt management so the credit counselor can assist you in completing your payments. But if you can discipline yourself to meet your payments, then debt consolidation loans and balance transfer can be a great option.