Between credit cards, medical bills, car payments and student loans, we bear a heavy burden of debt on our collective shoulders. And just when we make a monthly payment on one debt, another creeps around and gobbles up the scraps in our bank accounts. We end up paying more interest, and never seem to catch up to that original principle amount.
According to the Federal Reserve, consumers have $2.4 trillion in unsecured consumer debt. Approximately one-third of this staggering figure involves revolving debt, such as credit cards. The remaining 67 percent of debt is the result of our car, student and mortgage balances.
When we have too many balls in the air, a few are bound to fall—resulting in late payments, account delinquencies and credit dings. Fortunately, unsecured personal loans for debt consolidation can help you take back the reins and lead you to a better credit score faster.
The Basics of Debt Consolidation Loans
Think of an unsecured debt consolidation loan as putting all of what you owe into one convenient loan, so you’re submitting one monthly payment rather than several.
The number of monthly payments you may currently carry at varying interest rates can be enough to make your head spin. By contrast, these loans reduce your monthly surprises with a fixed rate that remains the same throughout the course of your loan.
However, because these loans don’t require you to put up collateral, interest rates will be higher than a home equity loan to balance out a lender’s repayment risk. Fortunately, these rates can also be lower than the variable rates on your credit cards.
All Your Eggs In One Loan Basket Can Be A Good Thing
Debt is like a weed—if you can’t control it, it’ll sprout up in other areas of your finances. An unsecured debt consolidation loan helps you quarantine those expenses to give your bank account a chance to grow.
First, these unsecured loans give more borrowers a chance to tackle their debt. While some derive these loans from their home equity or second mortgage, others can’t afford this same opportunity. So if you rent, or you’ve paid off your mortgage, you can still streamline your debts into one payment plan.
Second, debt consolidation loans give you a more comprehensive understanding of what you owe, how it should be paid off and how one fixed interest rate helps your bottom line.
Consider an example where you have three separate monthly debts:
- A $3,000 auto loan at 6 percent interest with $200 monthly payments.
- A credit card balance of $500 at 17.99 percent interest with $50 monthly payments.
- A $1,500 student loan at 3 percent interest with monthly payments at $100.
When paid separately, you’re forking over $350 per month to creditors. However, if you combined these into an unsecured loan with debt consolidation at an APR of 22 percent, you’d only pay $259.39 per month. This amount results in an overall savings of $90.61 per month.
Getting Started
The idea of both saving and streamlining your monthly payments should be incentive enough to make you want to sign on the dotted line for a debt consolidation loan. But you have to know where to start in order to maximize the benefits.
Add up your debts first. The total amount should be what you request for your loan. Resist the urge to tack on extra dollars to your loan for personal expenditures such as shopping or vacations. Not only will this add more interest on money you don’t need, but more importantly, it’ll distract from your primary goal to eliminate your debts in the first place.
It’s also important to do a little number crunching before you commit to these unsecured personal loans. Make sure that your potential interest rate isn’t adding to what you currently owe and that a consolidated payment plan won’t cost you more monthly than paying each bill individually—it would simply defeat the purpose.
But if the fixed interest rate isn’t quite to your liking, don’t give up. Shop around to see if you can find the right loan to lower your monthly payments.
Once the loan eliminates any of your credit card debts, you should significantly scale back or stop the use of those cards until the loan is paid off to avoid doubling your debt. The Credit CARD Act of 2009 ensures that creditors can’t charge you on the basis of inactivity. However, if your creditor’s terms outline that they can force account cancellation for inactivity, consider using the card for only a few small monthly purchases.
Understand that a debt consolidation loan will treat the symptoms of your debt, but not eradicate the problem as a whole. It’s up to you to stay the course in your discipline to not only pay off the loan, but to continue these finance behaviors once the debt is off your plate.
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