3 debt consolidation mistakes to avoid
If you are looking for a way to rationalize your debts, debt consolidation is a rather desirable option. “Debt consolidation is a technique used to combine several existing debts into a single loan, ideally with a lower interest rate,” explains Grant Sabatier, author of Financial Freedom: A Proven Path to All the Money You’ll Ever Need. When you do this, you’re taking a lump sum of money from a new source to pay off your old debts, he says. This source can be a credit card with balance transfer, a personal loan or the refinancing of your home loan.
While it’s easier and more convenient to make a single consolidated payment and may offer a lower interest rate, financial experts will warn you to proceed with caution. Missteps along the way could impact your credit rating or expose you to unexpected financial risk.
Here are three debt consolidation mistakes to watch out for when researching debt consolidation options.
Not understanding the terms of a balance transfer offer
While consolidating your balances is a worthwhile exercise, as you’ll have fewer debts, balances, and interest rates to track (because you’re combining multiple payments into one monthly payment), pay attention to the fine print of your debt consolidation. path. “There are pitfalls to this approach, and you’ll need to be careful if consolidating accounts through credit card balance transfers is your preferred approach,” says Lauren Anastasio, Certified Financial Planner and Director of Financial Counseling at Stashan online investment platform.
One caveat is that interest rates increase after an introductory period, so be sure to read the terms and conditions of the balance transfer agreement carefully and carefully. “It might seem like a lot if a card offers you 0% for 12-18 months on a balance transferred from another card, but chances are you’ll receive that promotional rate after paying 3-5% at the advance to make the transfer,” she explains.
According to Anastasio, this will increase your total debt and make your minimum monthly payment even higher. “These promotional rates also expire, so try to enter the process with the intention of paying the balance in full before the end of the promotional period,” she says.
Ignore credit score implications
Opening a new credit card for the purpose of transferring a balance can hurt your credit, says Anastasio. “Reapplying for credit and a new account when you already have balances can be a red flag to card issuers and other lenders that you’re not able to manage your debt,” she says. “You may find that you are unable to qualify for other offers or receive higher interest rates in the future when your credit score is lagging.”
There could be even greater credit implications if you transfer balances from one card to another and then another each time the promotional period expires. “Beware of the vicious circle of only paying the minimum. Just because you don’t pay a high interest rate during the promotional period doesn’t mean you get rid of your debt,” says Anastasio.
Failing to Recognize the Risks of Debt Rollover in Your Mortgage
Using the equity in your home to consolidate debt can be beneficial from a cash flow perspective. “Not only are you amortizing your payments over 30 years, but you’re probably also locking them in at a very low interest rate,” says Anastasio. This can significantly reduce your monthly obligations and improve your cash flow over time, she points out. But, she warns, there are risks to using your home as a “debt” tool.
Sara Ratner, credit card expert at NerdWallet, outlines the issues you need to be aware of during the debt consolidation process: It takes time, closing costs can be thousands of dollars, and you may need to take out private mortgage insurance if you don’t. have enough equity in your home. But putting your home on the line is even more serious, so make sure you’re able to pay your mortgage on time and in full. “If you can’t pay your mortgage payments in the future, you risk losing your home,” Rathner warns.
The essential :
When considering your debt consolidation options, it’s important to understand how you got here. Do you have any spend triggers? Are you opening new lines of credit due to overspending? Getting to the root of what got you into debt in the first place is definitely a step in the right direction. “If your spending habits aren’t responsible, consolidating your debt and paying off your balances will only free up credit so you can overspend again,” says Michael Cummins, chief financial officer at insurance geek. “You will find yourself in a vicious cycle of indebtedness and deleveraging.” Instead of continuing this cycle, Cummins advises tackling your spending habits and learning to be more responsible with money before consolidating your debt and paying it off.