How does Debt Consolidation Work
For borrowers with good credit, credit cards may provide a cost-effective method of debt consolidation for debts they intend to repay in 12 months or less. It may be possible to transfer balances from other credit cards to a 0% balance-transfer credit card and repay the total balance without incurring interest. Of course, 0% balance-transfer deals don’t last forever, so the best way to take advantage of them is to pay off the total balance before the interest-free period expires.
Unfortunately, borrowers with bad credit won’t qualify for any 0% balance-transfer deal. Indeed, depending on just how bad their credit is they may not qualify for any standard credit card and may need to rely on credit cards for bad credit. Providers of these types of credit card typically charge relatively high interest rates – 30% and more – but if you pay off your balance in full at the end of each month you don’t pay any interest at all.
Another method of debt consolidation involves taking out a loan to pay off existing debts. In doing so, borrowers consolidate all of their debts into a single debt with a single monthly repayment. The main advantage of a debt-consolidation loan is convenience. Instead of repaying numerous creditors at various interest rates at different times of the month, borrowers take out a loan large enough to repay all their existing creditors and make a single repayment on the new loan once a month.
Borrowers often choose to repay a debt-consolidation loan over a longer period to make their monthly repayments smaller and take the pressure off their finances in the short term. Of course, extending the repayment term may mean that they actually pay more interest on the loan, making it a more expensive option overall. Anyone thinking about taking out such as loan should carefully work out the full cost.
Borrowers with bad credit may find that they are not approved for a debt-consolidation loan or may only qualify for one with a higher interest rate. They may also have to pay an arrangement fee for this type of loan.