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How to Use Debt Consolidation to Lower Monthly Payments

How to Use Debt Consolidation to Lower Your Monthly Payments

If you’re struggling under the weight of high-interest debt across multiple credit cards or loans, debt consolidation can be an attractive option. By rolling all your debts into one new loan with a lower interest rate, you may be able to reduce your monthly payments and pay off your debts faster.

What to watch out for

However, debt consolidation loans do come with some risks to be aware of, including:

  • Closing accounts – When you pay off credit card balances with a consolidation loan, you’ll likely need to close those card accounts. This can temporarily ding your credit scores. And having fewer open accounts can lower your overall credit limit, which can also hurt your scores.
  • Lengthy terms – While consolidation loans have lower monthly payments, they may come with repayment terms of 5-7 years. By extending debt out longer, you risk paying more interest over the full loan term. Make sure to do the math to see if consolidation truly saves you money.
  • Losing card member benefits – By closing credit card accounts, you also lose out on any rewards points or cash back you’ve accumulated. And you won’t be able to take advantage of card benefits like purchase protections in the future.
  • Debt temptation – Some borrowers find themselves racking up new credit card balances shortly after consolidating debt. Without addressing underlying spending habits, consolidation won’t provide a long-term fix.

Tips for finding the best loan

If you’ve weighed the pros and cons and decided a debt consolidation loan is right for your situation, here are some tips for securing the best loan:

  • Check your credit scores – Your credit scores play a major role in determining your loan terms. Checking your credit reports and scores can help give you an idea of rates to expect. Those with good or excellent credit (690+ score) will qualify for the lowest rates.
  • Compare multiple lenders – Rates and fees can vary widely from one lender to the next. Comparing quotes from banks, credit unions, peer-to-peer lenders, and online lenders ensures you don’t leave savings on the table. NerdWallet’s personal loan calculator makes it easy.
  • Mind the fees – Some lenders charge hefty origination fees or prepayment penalties. Opting for no-fee loans helps maximize your savings.
  • Set up autopay – Enrolling in autopay from your bank account can score you lower interest rates with most lenders. Just be sure you have enough of a buffer in your account to avoid overdraft fees.
  • Pay off highest-rate debts first – If your consolidation loan doesn’t have enough funds to pay every debt in full, tackle the highest-rate balances first to maximize interest savings.

Alternatives to consider

Besides traditional consolidation loans, you may also want to consider:

  • 0% APR balance transfer cards – These cards allow you to transfer high-interest credit card balances and pay $0 interest for 12-21 months. Just be sure to pay off the full balances before rates spike back up.
  • 401(k) loan – If your retirement savings plan allows it, you may be able to borrow money from your 401(k) at low interest rates. Just know that this puts your retirement funds at risk.
  • Home equity loan – If you have substantial equity built up in your home, tapping into it via a home equity loan or HELOC can provide lower rates for consolidation purposes.
  • Debt management plan – Some nonprofit credit counseling agencies can negotiate with your creditors to reduce interest rates. You make one monthly payment to the agency, which distributes payments to creditors.

The bottom line

When used responsibly, debt consolidation can provide major savings in both time and money. Take time to run the numbers, compare all options, read the fine print, and address underlying spending habits that led to debt in the first place. This will set you up for successful debt repayment and improved financial health over the long haul.

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