It's no surprise that personal loans are frequently used as a means to restructure credit card debt. With the average U.S. household carrying over $15,000 in this type of debt, it's only natural that people are looking for ways to reduce their interest costs or lower their monthly payments. Often, a personal loan can help debt holders accomplish both while reducing the risk of late payments and overdraft charges.
However, when done incorrectly, this approach to debt consolidation can perpetuate the debt cycle and contribute to unsustainable levels of debt for families. That's why it is important to keep a few simple tips in mind when using personal loans in this way.
Tip #1: Maintain Your Debt's Duration
When taking inventory of your debt, it's easy to fixate on the interest rate and monthly payment. After all, those are the most immediately meaningful numbers that you're dealing with. That said, the duration of your loans is often just as important as these other indicators, and ignoring it can be costly.
For example, a debt with a 12% interest rate and an 18 month repayment schedule looks less attractive than one with a 10% interest rate and a three-year schedule. But, over the term of the loan, the second debt will cost you more than the first. The added duration will cause the lower rate loan to cost more interest overall.
That's why keeping the repayment schedule similar is so important. You'll know that the lower interest rate will lead to a real savings for you. This might not lead to as large of a monthly payment reduction as you'd hoped, but you'll save the most money in the long term.
Tip #2: Save or Submit The Savings
After you use a personal loan to consolidate your debt, you'll typically find yourself paying hundreds of dollars less each month--depending on your debt levels, of course. It's tempting to use this money to enjoy a higher quality of life than you were able to prior to consolidation. This is a huge mistake. It was often that lifestyle that got you into debt in the first place.
If your monthly payment goes down by $200, place that entire amount into savings or into repaying your loan. That way, you'll break the cycle of spending that caused your debt to rise in the first place. Also, nothing will improve your lifestyle more than removing the entire amount of your debt from your monthly obligations. So, focus on doing that immediately and you'll be that much closer to complete financial freedom.
Tip #3: Pair Consolidation With Tight Budgeting
Not everyone who uses personal loans to consolidate their debt is in financial trouble. Often, the attractive interest rates and convenient loan process makes a personal loan the right choice for a wide variety of situations. When you factor in credit card over-limit and late payment fees, it's no surprise that personal loan origination continues to rise.
However, even if you're having no trouble with making your monthly payments, use this process as a trigger to begin or revamp your budgeting process. Leaks, such as high utility costs and inflated entertainment expenditures, tend to creep into even the most disciplined households. When you consolidate, take a look at your:
- Monthly costs for phone, internet, and cable
- Weekly food and entertainment allowances
- Optional spending habits
If you can pair a lower debt payment with a lower monthly budget, you'll get ahead that much faster. It also makes it much more likely that you'll be able to pay off your personal loan on schedule or, in some cases, early. Think of the process as routine maintenance for your financial health.
From purely a cost standpoint, it's common for debt consolidation with a personal loan to be the right choice for folks in a wide variety of financial situations. By keeping these tips in mind when you do it, you'll be certain to get the most out of the experience.