Consolidating Your Debt: Why It’s Important and When to Consider It

Feeling like you’re drowning in debt? You’re not alone. According to the U.S. Census Bureau, 69% of American households carry at least some debt. If you’re looking for a way to get on top of this burden, you may want to consider consolidating what you owe, which can be an effective strategy for managing bills and paying off those obligations once and for all.

Understanding debt consolidation

Multiple bills from auto loans, credit cards and a mortgage often come due at different times, fostering a perfect climate for human error. Even one forgotten bill can result in costly interest and late fees, and simple arithmetic mistakes can lead to overdrafts and even more penalty fees.

Debt consolidation involves combining payments to many lenders down to one, often a sum that’s less than the total of the individual bills it replaces. This makes it easier to stay on top of finances, improve credit and reduce overall debt. But keep in mind that cutting back what you pay each month may mean you’ll ultimately be charged more interest by the time you eliminate what you owe.

Why now?

One of the main benefits of debt consolidation is that it can reduce interest on what you owe, which brings down what you pay each month. Although rates are still holding at near historic lows, the Federal Reserve is currently deciding when to allow them to rise. So you may be able to avoid higher costs by acting soon and locking in low-interest financing. The advantages can be even greater if you’re carrying debt with variable interest rates, which will undoubtedly climb in the not-too-distant future.

Consolidation options

Several ways to consolidate debt are available, each with its own advantages and considerations:

Home equity financing

Homeowners who owe less on a mortgage than the market value of their property may be able to put the resulting equity to work to help pay off high-interest credit cards and other debt and reap the added advantage of a tax benefit in most cases. This type of financing has two major options: home equity loans, which are a type of second mortgage, and home equity lines of credit (HELOCs). Both are considered secured financing, using real estate as collateral, so a dependable income is required. Credit unions often offer the most competitive rates, and you may be able to borrow up to 90% of the appraised value of your house.

Personal loans

For those who aren’t homeowners or prefer not to use their property as collateral, a personal loan can provide another avenue to consolidate debt. Available as secured or unsecured financing, these loans typically carry a somewhat higher interest rate than home equity financing; however, the rates available through some financial institutions can still reduce your overall monthly payments.

Credit card balance transfers

Balance transfers offer a way out of high-interest credit card debt by moving what you owe to a new card with a lower rate. Some card companies offer very low or even no interest introductory periods, typically six months or more. Consider this option if you can pay off the full transferred amount before the low-rate period expires and a higher rate takes effect.

When consolidation can help

Juggling a stack of bills each month from multiple lenders? Or is a hefty balloon payment looming? Perhaps you’re just stuck paying interest at a much higher rate than what you can get on new debt today. When financial burdens become unmanageable, the time is right to talk with advisers at your financial institution to see whether consolidation can be a cost-effective way to bring your budget back under control.

Roberta Pescow, NerdWallet

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