The New York Federal Reserve recently released its Quarterly Report on Household Debt and Credit. In it, they reported consumer debt in the United States increased by more than $85 billion in the third quarter of 2020, hitting an all-time high of $14.35 trillion.
With Americans looking for new ways to successfully manage their debt, many are beginning to explore debt consolidation options during a global pandemic. The current record low interest rates, coupled with the opportunity to eliminate multiple interest payments on various accounts, are encouraging borrowers to save money through debt consolidation.
What is debt consolidation?
Debt consolidation means you take out a new loan to pay off other debt, such as smaller loans, bills, or credit card debt, that you currently make monthly payments on.
With the new loan, you can get rid of multiple smaller payments and their interest charges and make a single payment on your new loan. In other words, you “consolidate” all your small payments into one more manageable payment.
Debt consolidation through a mortgage
Did you know you can refinance your current mortgage and use the money to consolidate your debt? This type of debt consolidation can be especially effective if the loans you’re looking to consolidate are high-interest and the bulk of your monthly payments is going toward the interest, not the principal.
With a home refinance loan, you can access up to 80% of your home’s appraised value (less the amount remaining on your current mortgage).
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Pros and Cons of Debt Consolidation
Borrowers often turn to debt consolidation in order to combine credit card debts, student and auto loans, medical or other debts. This allows borrowers to make a single monthly payment instead of multiple payments for each individual debt. This makes it easier and more straightforward to get and keep your financial well-being in order.
But debt consolidation offers more benefits in addition to simplifying your finances. Debt consolidation can also offer borrowers an opportunity to get a better interest rate with better loan terms than the original debt.
Pros of debt consolidation
In addition to making your debt more manageable and chopping your interest rates, debt consolidation can offer several valuable advantages, including:
- You can reduce your Credit Utilization Ratio. This is the ratio of your debt to your credit limit. In other words, how much of your available credit are you using? The lower the percentage, the better for your credit health. Paying off several debts with a debt consolidation loan helps you to use less of your available credit.
- You can get out of debt sooner. A debt consolidation loan can help you get out of debt sooner, especially if you're carrying consumer credit card debt, which can have you paying high-interest rates for years. Paying off debts faster allows you to start putting money toward financial goals, such as a college or retirement fund, sooner.
- Create a fixed repayment schedule. When you use a debt consolidation loan to pay off your existing debt, you get the same interest rate for the entirety of the loan. That means you know precisely how much is due at the end of the month and when you will have successfully paid off the entire debt. When you create a fixed repayment schedule, there are no surprises. You won't get hit with an unexpected bill or a payment amount that suddenly increases by a couple of hundred dollars.
- Improve your credit score. Debt consolidation can help improve your creditworthiness in the long run. Because your payment history accounts for more than a third of your overall credit score, making monthly debt consolidation payments in full and on time each month will improve your credit score.
Cons of debt consolidation
Debt consolidation comes with some good advantages, but it has a few disadvantages as well, including:
- It won't improve your financial habits by itself. Understanding why you got into debt in the first place is essential to ensuring you don't repeat the situation now that your credit cards and other bills are paid off. While a debt consolidation loan will help you get a handle on out-of-control credit, you'll need to pay attention to your spending habits to protect yourself from falling into a similar situation in the future.
- There can be fees associated with getting a debt consolidation loan. These fees can include closing costs or annual administrative fees. The good news is, specific fees, like closing costs, can often be rolled into the total amount of the loan so that you don't need to pay them when you get your money. Instead, they are added to the loan's principal.
- It can add extra years to your mortgage. If your current mortgage term is 10 years, refinancing your mortgage to consolidate and pay off your debt could add additional weeks or years to the lifetime of your mortgage, which some borrowers might find frustrating.
Getting rid of debt can be liberating. It can give you a second chance at managing your finances and rebuilding your credit. If you are experiencing an ongoing budget shortfall, debt consolidation can't cure the initial cause of debt accumulation. However, it can give you some much-needed breathing space to address and take action while making any course corrections you feel are necessary.
Debt consolidation can be an effective tool for anyone looking to simplify their monthly budget or take advantage of lower interest rates and save money.
Everyone's financial situation is unique, and there's no "one-size-fits-all" debt consolidation strategy. That's why we want to sit down with you and go over the various options available. We want to help you decide what the best option is for you and your family. Mortgage refinancing can offer significantly lower interest rates helping you save money while eliminating debt.If you have questions about how you might benefit from debt consolidation, reach out to the regional home loan officers at River City Mortgage today. We're ready to work with you to find the best choice for your family's financial health.