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Ultimate Guide to Debt Consolidation

July 28, 2022 • Education

If you’re struggling with multiple payments, high interest rates, or a strapped monthly cash flow, debt consolidation may be an option to consider. Debt consolidation is a process which allows the burden of loan repayment to be spread over a longer period of time. It usually also means a merged, single monthly payment with a set, fixed interest rate. Knowing exactly how much you need to pay on your debt every month and for exactly how long you’ll need to make that payment can make it easier to budget and work towards your additional financial goals.

Because debt consolidation transforms the burden of repayment to one that’s spread over a longer period, this can often mean that the process of paying off the debts becomes more manageable. For example, if someone is trying to pay off 12 different credit cards, all with varying interest rates, balance amounts, and due dates, they may find themselves short when it comes to their cash flow for their other budgetary needs from the duration of their last credit card payment until their next paycheck. This can lead to a cycle of adding more debt to cover their cash flow shortage, and it only grows exponentially over time if it isn’t handled.

ultimate guide to debt consolidation image of empty wallet with bills and credit cards in the backgroundThere are many benefits associated with debt consolidation. Some perks that many people don’t consider is that it could increase your credit score, reduce your overall interest rate, lower your monthly debt payments, lower your risk of falling into collections or garnishments, and free up monthly cash flow that you'll be abel to use for your other budgetary needs.

With all of these benefits, it may seem like a no-brainer to roll your existing debt into a debt consolidation loan, but there are some downsides to keep in mind when going through the process. Before applying for a debt consolidation loan, we always recommend carefully reviewing the pros and cons and considering how they apply to your specific situation.

Pros of consolidating your loans:

1) It saves you the trouble of keeping track of and making multiple payments to different lenders every month.

2) You can get a lower monthly repayment amount, freeing up left over cash flow for other items in your budget.

3) You can have peace of mind knowing that your money is being paid on time, particularly if you opt for an automatic repayment plan.

4) You may be eligible for lower interest rates than what you have with your current debts.

5) You can potentially lower the total amount you have to pay on all of your debt.

Cons to consider before opting for a debt consolidation loan:

It should also be noted that there can be cons to debt consolidation. If your spending habits and budget haven’t been organized and handled, it very well could lead to a cycle of taking on more and more debt which leads to eventual financial failure. This can be avoided by understanding your personal money spending habits, being diligent, and only use these consolidation methods in extreme cases when absolutely necessary to save yourself from drowning in too many credit card or debt repayment bills.

For example, if you combine all of your credit card debts into a debt consolidation loan, but continue to spend more than you are bringing in every month by over-using your credit cards after the fact, then you will only be adding more to your mountain of debt. A short time of this and you'll be right back where you started, with mutiple payments that you need to make every month, only now you'll also have a consolidation loan payment to make. Not good!

A debt consolidation loan doesn’t get rid of your debt, it simply reorganizes it by consolidating it into a single payment. You will still be responsible for making sure that there is enough buffer in your budget to make your debt payment and cover the rest of your household needs.

An additional con could be if the debt consolidation loan comes with a higher interest than the debt you are rolling into it. This is why we strongly advise against debt consolidation lenders that only offer short-term or high interest loan options. A loan of this type only makes sense if you can save on these factors.

Another consideration to keep in mind is if your current debt offers certain tax deduction benefits, such as a mortgage or student loan debt. Rolling these types of debt into something like a personal debt consolidation loan would strip it of these benefits, so there needs to be careful consideration and calculations made as to whether or not any savings on the interest or term of the loan is worth making the switch.

From Several Payments to One Easy Bill

One of the central benefits to rolling multiple debts into a single consolidation loan is that it allows you to have one singular monthly payment instead of multiple ones. Finally, you’ll be able to stop worrying about late or missing payments and any of the potential fees that comes from them any time that happens. You will have one monthly payment for the life of the loan. For most people, a single payment is a lot easier to keep track of.

If you long for a more manageable monthly budget, with an eventual debt-free future, then rolling your debt into a consolidation loan may be a solution. Often, it’s the first step our members take when taking back control of their finances and their life.

For most people, accumulating debt is part of life. When we’re just starting out, or trying to get back on our feet after a set-back, our process often includes the need for debt to get us in the position where we need to be. Some of us end up with higher balances due to poor spending habits, unexpected set-backs, or calculated life decisions to take on debt now with a plan to pay it off later. Regardless of the reason, the fact remains that most people will be in some form of debt at some point in their lives. At Canopy Credit Union, we aren’t here to shame anyone for what choices or circumstances brought them into their current fianncial situation, we’re only here to help you find the best solution that meets your particular needs.

Cash flow shortages are the main reason a lot of us go into debt in the first place. This is why it's so important to know the best ways to maintain a healthy balance between your income and your expenses, so you can avoid accumulating more debt than you already have.

Who Should Get A Debt Consolidation Loan?

If you are drowning in debt and don't know where to start, there are many different ways to manage your debts. One of the most common methods is debt consolidation. The idea behind it sounds simple: take out a single loan to pay off all of your other smaller ones. Debt consolidation can be done in order to reduce monthly payments, lower interest rates, break up a large amount into smaller payments, and improve credit scores and more. If it’s a struggle to make all of your monthly debt payments on time and still have something left over for the rest of your budget, this is a solution we would highly recommend.

Types of Debt Consolidation Loans

There are many types of loans that can be used for debt consolidation. Some of the options we offer at Canopy Credit Union include personal debt consolidation loans, cash out auto refinance loans, home equity loans or lines of credit, balance transfers to our low-rate VISA credit card, or, for smaller amounts, our payday alternative loans. See below for more details on each type of debt consolidation loan.

Personal Debt Consolidation Loans

There can be times in your life when you need a loan but can’t or don’t wish to offer any collateral (such as a car, house, etc.) to back it up, and you don’t want to add another monthly credit card payment to your pile. This is when a personal loan makes sense as a tool for debt consolidation. With a personal loan you don’t need to secure it with any collateral, there are no restrictions on what you can use it for, and the rate is a simple, fixed amount so you’ll know exactly how much you’ll be paying on it every month.

Most of the members who take out personal Loans at Canopy credit union use them to consolidate and pay off credit card debt, pay for emergency expenses, or refinance other, higher-interest debt. If you think that a personal loan may be the option you need to get out of the cycle of high interest debt, we offer a fast and easy application process here.

Cash Out Car Loan Refinance

Most people don’t think about the equity they’ve accumulated in their car or truck. Typically when people think of a cash-out refinance, homes are what come to mind, which isn’t an option for a lot of members in our community. If you have equity in your car however, you can use it as collateral for a cash-out refinance loan to help you pay off your other, non-car payment debts. Not only could we potentially get you a better interest than you are paying on it currently, but you will be able to apply that same fixed interest rate and payment amount to your other debts, saving you a bundle in the long run!

Home Equity Loan, Home Refinance Loan, and Home Equity Lines of Credit

However, if you do own a home and have some equity paid into it, then tapping into that equity as a means to pay off your higher interest debt can often be the most affordable way to consolidate your other high interest debt payments.

Refinancing your home typically makes sense when it’s going to drop your interest rate by 0.75% or more, or if you will be able to shorten the term of your loan, especially if it’s by 5 years or more. In either of these cases, refinancing can save you even if you don’t use a cash-out option to pay off other outside debts. Sometimes freeing up cash flow with a small mortgage payment gives you enough wiggle room to pay off your additional debts without the need for consolidation.

However, if you are looking into using the value of your home as a means to pay off your other debts as a source for a debt consolidation loan, then there are two option you can apply for. The first is a home equity loan, and the second is a home equity line of credit (or HELOC, for short.)

A Home Equity Loan allows you to borrow a part of the value of the equity built into your home. They can serve the purpose of debt consolidation well because it serves as a set amount that you borrow and then pay down, offering the reassurance of a fixed, monthly payment.

A HELOC on the other hand operates as a line of credit. That means it’s more like the balance of a credit card, except like a Home Equity Loan it’s based on the value of your house. With a HELOC through Canopy Credit Union, you can draw from the equity for up to 8 years, only making interest payments on the amount you borrow during this time. Then, for the following 15 years you would make set monthly payments based on whatever balance you have left from the draw period. What’s unique about the HELOCs with our credit union is that we offer set, fixed interest rates. Most other financial institutions offer variable rates, meaning the interest you pay could be different depending on when you draw from your line of credit. This element makes our HELOCs particularly beneficial for using as a debt consolidation tool.

Credit Card Balance Transfers

For smaller debt amounts it may make sense to roll the balances over several cards into a single credit card with a low interest rate. While the rate on credit cards isn’t fixed, so the exact amount of your monthly payment may fluxuate, consolidating with one still allows you to transform several payments into one, and often the rate with a credit union card is going to be significantly lower than the rates charged by major credit card issuers.

If you are going to use a credit card as a debt consolidation method, we would recommend our Classic Visa Card. It offers a slightly lower interest rate than our uChoose Visa Rewards Card, doesn’t charge an annual fee, and includes real-time security alerts. Another unique benefit is that we don’t close credit card accounts due to inactivity. If you use one of our VISA cards to consolidate and pay off your debt, you can keep the account open however long you’d like even after you’re done making all of your payments. Every month the card will report to the credit burue agencies as being paid, giving your credit score a boost the longer you have the card. You never even have to use it to get the benefit!

Fixed Versus Variable Interest Rate Loans

There are two types of debt consolidation loans: those with a fixed interest rate and those without. If you want the lowest possible interest rate, you’ll want to go with a fixed rate consolidation loan. A fixed rate also ensures that you’ll know exactly how much your payment will be on your loan every month. If you aren’t sure which if these two options makes more sense for your situation, please reach out to us to discuss. We are always happy to help you make the best choice for your needs.

Next Steps

Many people who have spent years in debt, are eager to know how to manage their finances. Taking out a consolidation loan can be an important step in reaching this goal. It is, however, only a part of the overall equation.

After determining how much you need and what kind of loan you’re going to use to consolidate your existing debt, the second step to take is figuring out how long it will take to repay your new consolidated debt. Your calculations will vary depending on how much money you borrow, and the interest rates that it comes with.

When you consolidate your debts, your interest rates go down, and they are usually fixed for the duration of the loan. So, even if your debt goes up after you consolidate it, chances are it will stay relatively stable. It can help you get out of debt faster and save money on interest.

To make the most of your debt consolidation, you’ll want to maximize the cashflow opportunities it presents to you. If, after consolidating your loan you find you have some extra cashflow in your monthly budget that you didn’t before, you’ll want to plan and budget carefully to ensure that you aren’t squandering it or finding yourself accumulating more debt as you pay off your consolidation loan.

Working with one of the free financial coaches at Canopy Credit Union is a personalized way to learn how to set up a spending plan and budget unique to your personal financial situation. Over an in-person or virtual zoom call we can help you establish a budget and spending plan, set short and long term financial goals, put a plan together to pay off collections or garnishments, pay off debt, increase your net worth, and more.

Our coaches will provide you with specific, actionable steps you can take to move forward on your financial goals. Our coaches are certified through the National Credit Union Association (CUNA) and they are always free to meet with, whether you are a member of Canopy Credit Union or not! If you aren’t sure if a debt consolidation loan is the right fit for your current situation, booking a session can be a great place to start. And if you have already booked a debt consolidation loan and you want to make sure you steer clear of the situation that brought you into debt in the first place, then it also makes sense to meet with one of our coaches.

Finally, once you have successfully paid off all of your debts, you’ll have a great decision to make: what to do with the extra cash flow you’ll have that will no longer being spend on your monthly payment! We suggest a carefully considered plan, one that incorporates savings, goal-setting, and budget building to help keep you in a good place financially while preventing the need to take out more debt in the future.

Hopefully this guide has helped you determine whether or not a Debt Consolidation loan is a right fit for you, and if so, which avenue would work best. As always, if you have any questions or would like to learn more, please feel free to give as a call at 509.328.2900 or stop in to any of our three branches in the Spokane and Spokane Valley area. We’d love to hear from you!

Bonus tip: Once you consolidate your debt, talk to a member advocate about setting up automatic payments! You can set up your account so every time you get paid, a certain amount automatically goes towards your loan payment.

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