After staring at a growing pile of bills, you’ve decided to get ahead of the situation through a debt consolidation loan. Compiling various current unsecured debts into a single, more manageable monthly payment can reduce some of the stress you’re feeling. It can also help you save money, as you’re no longer paying all those high credit card interest rates every month.
To get the most out of your efforts, watch out for these five debt consolidating mistakes to ensure you don’t find yourself in a similar situation again in the future.
What is a Debt Consolidation Refinancing Loan?
When you refinance your mortgage to consolidate debt, you can borrow money on your mortgage to pay off other debts. The money you borrow is added to your current home loan. Your debts aren’t separate from your mortgage; instead, they are rolled into it. The result is one mortgage, one monthly payment for all of your debts.
Before You Apply
Take some time to evaluate your current financial situation before you apply for a consolidation loan. List which debts you want to consolidate and note the interest rate for each debt.
You may be able to pay off one or two of the smaller debts without consolidation. For example, if you have a short-term debt such as an outstanding utility bill or a credit card on a low-interest introductory rate and a minimal balance, paying them off might be more manageable. This has two benefits, you can get rid of the small debts, and your debt consolidation loan can be for less money. Once you have a clear picture of your finances and know what you want to consolidate, you can begin exploring debt consolidation options.
Avoid These Five Debt Consolidating Mistakes
Let’s look at the five of the most common debt consolidating mistakes and what you can do to avoid them.
1. High Interest Rates
One of the debt consolidating mistakes to avoid is paying too much in interest.
Debt consolidation can be a smart financial choice when accompanied by a lower interest rate compared to what you’re currently paying. Too-high of an interest rate can make repayment of your debt consolidation loan more challenging, increasing the potential for missed or late payments.
Because today’s record low refinancing interest rates range between 2.25% and 4% — considerably lower than most consumer credit card rates, which can top out around 25% — you can easily sidestep this debt consolidating mistake.
2. Taking Too Long To Pay Off Debt
How long it takes you to pay back your debt consolidation can impact your overall financial well-being. While the longer you take to repay your consolidation loan will generally result in lower monthly payments, the downside is that you end up paying more interest over the lifetime of your loan.
Think of it this way: Imagine the debt you are consolidating would have taken you three years to pay off if nothing changed. If you get a debt consolidation loan with a lower interest rate, but you stretch your repayments term to seven years, you could potentially end up paying more interest than if you had kept things the way they were.
To avoid this potential trip-up, look for the shortest possible repayment time frame and not solely on the monthly payment amount. When you consider the overall “big picture,” it can help you determine the best financial choice for your specific situation.
3. Accumulating More Debt
When you roll multiple debts into a single monthly payment, it can feel like you’re getting out of debt sooner. Seeing credit cards with a zero balance can have a strong pull on our desire to treat ourselves or make other unnecessary purchases. That’s why one of the big debt consolidating mistakes to avoid is accumulating new debt.
While a single dinner out won’t likely disrupt the good financial choices you’ve set in motion, dining out several nights each week in celebration of your debt consolidation loan can add up quicker than you might have imagined.
4. Canceling All Your Credit Cards
Once you get rid of your credit card balances, you might feel like canceling them, but it might be worth keeping them. It can be worthwhile to carry a zero balance once you’ve used your consolidation loan to pay off these debts.
Having credit available on your credit cards but not using it is not only a great exercise in financial restraint and self-control but having credit cards with a zero dollar balance is also beneficial for your credit rating. This can translate into better interest rates in the future for big-ticket items like a new home or mortgage refinance.
5. Using Your Old Budget
A debt consolidation refinance loan can help make expenses more manageable, but it’s important to rework your monthly budget to fit your new situation.
Once you pay off the other debts, you may find that you have a little extra cash at the end of the month now that you’re not paying all that extra interest. The temptation to spend that additional cash can be significant, but it’s important to consider the best use for any financial excesses you may have carefully.
Can you add to your emergency fund? Can you make additional payments on your debt consolidation loan? Can you save up for a purchase and avoid putting it on credit (this can be an exceptionally effective trick for saving money, and you might even get a discount by paying cash).
Refinancing your mortgage to consolidate debt can be a straightforward way to streamline your finances. And the more manageable your payments are, the less chance there is that you’ll miss a payment.
By keeping an eye on these five debt consolidating mistakes, you can simplify your debts, making repayment easier, cheaper, and faster.If you’d like more information about the different refinancing options, we’re here to help. Get in touch with the licensed loan officers at River City Mortgage today. We’re happy to walk you through the entire process, go over all the options available to you, and help you find the right refinancing choice for your situation.