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Debt Consolidation: What It Is and How to Use It

Debt Consolidation: What It Is and How to Use It

Americans have faced some challenging financial issues over the past few years, and we have the debt to prove it. Total household debt increased 2.4%, to $16.9 trillion, in the fourth quarter of 2022, according to the Federal Reserve Bank of New York (FRBNY), with notable increases in credit card, mortgage, auto loan and student loan balances. Credit card balances saw their largest annual increase since FRBNY began collecting this data in 1999, growing by $130 billion, to $986 billion, from December 2021 to December 2022.

The good news is that if you are among those trying to navigate unwieldy credit card and/or loan balances or payments, debt consolidation may be a helpful option for you. Consolidating debt — bringing multiple balances together under one loan or credit card — helps streamline personal finances by requiring just one payment versus multiple payments each month. Depending on your creditworthiness and the consolidation option you choose, you may also be able to reduce your interest rate, pay less each month and pay your debt off more quickly.

Is debt consolidation right for you?

If you have been consistently making monthly payments toward your debt without making much progress toward paying it off, it may be time to explore consolidation options. Generally, consolidation works best when you have:
  • A good, very good or excellent credit score – A FICO® Score of 670 (good) or above may help you secure a loan with favorable terms and a lower interest rate.
  • High-interest debt – Interest charges can snowball over time, especially if you are making just the minimum monthly payment. If you qualify for a lower interest rate loan or balance transfer credit card, consolidating your debt could allow you to save money on those interest charges.
  • A repayment plan – If you take out a consolidation loan, you will have set payments and a set date to pay off your loan. If you consolidate under a credit card, then you will need to establish your own payoff schedule and stick to it to ensure you meet your goal.
Dollar Bank’s Debt Consolidation Calculator can help you get an idea of how debt consolidation might change your monthly payment, total interest costs and the time it would take to pay off your debt. (Dollar Bank offers a variety of Financial Calculators to support your personal financial management needs.)

3 common ways to consolidate debt

There are many approaches to consolidating debt. These three are among the most commonly used:

1. Balance transfer credit card. Balance transfer credit cards are designed to enable you to move outstanding balances from other accounts (up to a specified credit limit) with the objective of saving on interest. Many offer an introductory 0% APR for a limited time, meaning you don’t pay any interest until that promotional period ends. Balance transfer credit cards generally charge a one-time fee of 1-5% (with a $5 or greater minimum fee set by the card issuer) on each balance being moved. This fee can seem nominal when compared with the potential interest savings, considering credit card APRs can at times exceed 20%.

A balance transfer credit card can be a good choice when you are consolidating debt that you know you can pay off within the promotional APR period. Do the math up front to see how much you need to pay each month to achieve that goal, and then make those payments consistently to avoid paying any more interest on that debt.

2. Personal loan. When you consolidate your debt under a personal term loan, you take out a new loan that will cover the sum of the balances you owe, pay off each of those balances with the money you’ve borrowed and then make payments toward the new loan. A personal term loan offers several advantages:
  • A fixed rate and fixed monthly payment, which can make budgeting easier and protect you from rising interest rates
  • The certainty of a predetermined payoff date — as long as you make your scheduled payments, in full and on time, you will pay off your debt by the predetermined date set in your loan terms
  • An interest rate that may be lower than what you’re currently paying on your debt
Because a personal loan is unsecured, meaning you don’t have to put up collateral toward the money you borrow, you need to have good credit score and meet other financial criteria to qualify. Your creditworthiness will influence your interest rate, too: People with strong credit tend to earn lower interest rates.

3. Home equity loan. Like a personal loan, a home equity loan provides a lump sum to pay off your owed balances. It has a fixed interest rate and payment schedule. For this type of loan, your home’s equity — the difference in its market value and what you owe on your mortgage or other loans secured by your home — serves as collateral. Because a home equity loan is secured, it may have a lower interest rate than unsecured options such as personal loans and credit cards.

The benefits of debt consolidation in today’s rising-rate environment

The Federal Reserve Bank’s efforts to stabilize prices in the inflationary economic environment of 2022-2023 have included raising the federal funds rate more than a half-dozen times. That affects the cost of borrowing by pushing credit card and other types of interest up. Consumers with outstanding credit card balances or variable-rate loans are paying more for that debt than they may have expected, and it may take longer for them to pay it off.

For many, debt consolidation is a smart solution. Qualified borrowers who can secure a lower, fixed interest rate can save money on monthly payments as well as the total cost of carrying their debt. They also gain the peace of mind that comes with knowing they are taking control of their debt and committing to paying it off. To those who have been watching their balances grow due to rising interest rates, that certainty is welcome relief.

To learn more about debt consolidation solutions, visit your local Dollar Bank office, schedule an appointment or call us at 1-800-242-2265.

This article is for general information purposes only and is not intended to provide legal, tax, accounting or financial advice. Any reliance on the information herein is solely and exclusively at your own risk and you are urged to do your own independent research. To the extent information herein references an outside resource or Internet site, Dollar Bank is not responsible for information, products or services obtained from outside sources and Dollar Bank will not be liable for any damages that may result from your access to outside resources. As always, please consult your own counsel, accountant, or other advisor regarding your specific situation.

Posted: April 12, 2023