Using a personal loan for debt consolidation can have some real advantages, but unless you approach it the right way it could also make a bad debt situation worse.
Consolidating debt into a personal loan could lower your borrowing costs and make your debt payments easier to organize. However, it is not a miracle cure for your debt problem and debt consolidation can have risks. Make sure you find a cost-effective consolidation loan, and use discipline so the loan is a tool for reducing debt rather than simply as a means of facilitating more borrowing and spending.
Here are four tips to help you succeed by using a personal loan for debt consolidation:
1. Do some detailed personal loan shopping
A big advantage in using a personal loan for debt consolidation is that personal loans generally carry lower interest rates than credit card debt. This is especially true now.
The gap between credit card rates and personal loan rates has been widening, according to figures from the Federal Reserve. The average interest rate now being charged on credit card balances is 16.46 percent, compared to an average rate of 10.12 percent on a two-year personal loan.
That rate advantage of more than six percent for personal loans looks good on paper, but not all lenders offer the same rate. Personal loan rates vary from lender to lender, and your financial situation can affect the rate you are offered. So, compare multiple lenders and look past the advertised rate to find out what they offer someone in your financial circumstances.
2. Figure out your cost-saving opportunities
If you have multiple forms of debt, they may have very different interest rates. Don't assume it's the right move to pay them all off with a personal loan.
Chances are you could save money by consolidating credit card debt into a personal loan, but check the rate charged on each credit card balance before you assume this is true. Be sure to factor the closing costs for a personal loan into the cost comparison.
While credit card debt is particularly expensive, other forms of debt such as mortgages, car loans and student loans generally carry much lower interest rates. If you have these cheaper forms of debt, it may be more cost-effective to maintain those existing loans rather than roll them into a personal loan.
3. Budget before borrowing on a personal loan
A big danger with debt consolidation is that by paying down your credit card balances you might be tempted to use the credit limits you've just freed up to spend more than you should.
A debt consolidation loan should be part of an broader debt reduction plan. Before you sign up for a personal loan, look at what the payment schedule would be. Figure out a budget that allows you to keep up with that schedule while not ramping your credit card debt back up again.
You may even want to take steps like reducing the number of credit cards you have or not generally taking them with you when you leave the house.
4. Keep your debt consolidation loan payments on time
Your debt consolidation loan payments should be cheaper and more concentrated than trying to pay down a variety of credit card balances all at once. Take advantage of that by making it a priority to keep up with the personal loan repayment schedule and prioritize the debt you pay off first.
If you fall behind on your debt consolidation payments, you may find it much more difficult to get a similar type of loan in the future. In other words, this debt consolidation loan may be the best shot you are going to have to get out of the debt hole, so make the most of it.
Throughout all phases of this process, stay focused on the idea that a personal loan for debt consolidation should be a transitional tool. Rather than continually trading one form of debt for another, you should use your loan as a means of reducing and eventually eliminating your overall debt burden.