Debt consolidation helps you streamline your monthly debt payments and can lower your interest rate at the same time. You’ll need to choose the right debt consolidation lender to ensure you get the best deal possible, but you’ll also want to avoid common mistakes that could cost you thousands of dollars over the years.
This guide goes over some of the most common mistakes, shares tips on how to avoid them, and highlights the importance of planning to improve your financial future.
Be sure not to make these mistakes when consolidating debt.
Failing to research and compare lenders
If you go with the first lender you communicate with, you may miss a much better deal or lower rate. Not every lender is created equal, and some lenders are predatory or offer unfavorable rates and terms. Comparing and researching lenders ensures you end up with the best deal possible.
During your search, get numerous quotes and learn about the interest rates, term lengths, and fees on offer. Also, check out third-party reviews to see what past customers think of a lender. This research takes time and effort, but ensures you end up with a debt consolidation solution that you’re happy with.
One of the main reasons to consolidate debt should be to get a lower interest rate. If you consolidate all of your high-interest debt into a loan with a similar rate, it won’t save you much (if any) money in the long term. And the last thing you want is a rate that’s even higher than those on your other debts, making it more expensive to pay off.
Conversely, if you can secure a rate that’s even slightly lower than your existing rates, it could save you hundreds or even thousands throughout your term.
Make sure you know the actual rate you’ll be paying before agreeing to any debt consolidation option. Also, watch out for loans with rates that change. For example, a lender may offer an attractive initial rate which jumps to a much higher one after a few months.
While many lenders are upfront about all their fees, others aren’t so forthcoming. Unscrupulous lenders may also hide unfavorable rates and restrictions in the fine print of your contract.
The most common hidden fees include loan origination fees, prepayment penalties, late or missed payment fees, administrative fees, and insurance premiums. The exact size of each fee varies from lender to lender. These fees aren’t necessarily unusual or predatory, but knowing about them is important.
To avoid being surprised by hidden fees, read through every line of the fine print before signing your contract. Ensure you know the rate (and any rate changes), the repayment terms, whether there’s any collateral, and what fees or penalties you’re responsible for. If you’re struggling to understand anything, don’t hesitate to reach out to an independent professional who can interpret it for you.
If you don’t change the habits that got you into debt in the first place, you’re likely to end up in trouble again. A good way to identify/fix these habits is to create a budget.
Your budget tracks your income, bills, debt payments, “fun” spending, savings, and anywhere else your money goes. There are several types of budget plans, so make sure to choose the one that best fits with your needs.
For example, some people swear by the 50/30/20 plan. This budget tracks three different spending categories: Needs, discretionary spending, and your financial goals. Fifty percent goes to your needs, which include rent/mortgage, utilities, groceries, and other bills. Thirty percent goes to your discretionary spending, like shopping, dining, or events. The remaining 20% goes towards saving, paying off debt, or investing.
There’s no right or wrong option, and the best budget is the one you’ll stick to. Many people use spreadsheets and various apps to keep track of their budgets, as well.
At the end of each month, you should be able to quickly refer to your budget to see where your money went and how much you spent. Make sure to monitor and update your budget as your circumstances change, and be diligent about sticking to it. A budget only works if you’re willing to put in the work.
Ensure your consolidated debt payments are realistic for your financial situation. If not, you could end up paying more than you can afford, which can lead to missed payments on utilities, rent, or even the debt consolidation loan itself.
Once you’ve worked out how much you can afford to pay, you’ll want to consider what other expenses you might have in the future.
Consider also that lower monthly repayments usually mean a longer repayment term. This means you’ll pay more interest over the years than if you had a shorter term with higher monthly repayments. Ultimately, you need to find a happy medium between term length and payment amount, and ensure that whatever plan you choose is one you can stick to.
As far as how much you should allocate for debt repayment, it depends on your situation. Those with high-interest credit card debt generally want to pay it down more aggressively than someone with a low-rate loan or an interest-free period on their card.
Some people are also comfortable holding onto debt and paying it off slowly, whereas others get stressed when they owe money to others and prefer to get rid of it quickly.
Financial planning is an important part of dealing with debt and improving your financial outlook. Once you’re out of debt and the consolidation loan is paid off, you need to develop solid financial habits to avoid a similar situation going forward. Here are a few tips to help you better plan for the future.
Set goals for yourself
First of all, you should set some financial goals for the future. This gives you something to work towards and provides motivation for saving.
Your goals could include saving for a car, a down payment on a home, a nice vacation, or your children’s college education. If you find large goals are overwhelming, consider breaking them down into something more manageable.
Build an emergency fund
There’s no avoiding emergencies, but they become much easier to handle if you plan for them. Building an emergency fund to pay for unexpected expenses is one of the first things to do after getting out of debt.
Even if you can only afford to put away a small amount each month, start building up this fund over time. You should eventually aim to have around 6 to 12 months of expenses in the fund. This gives you peace of mind that even if you lose your job, get in a car accident, or suffer an injury, you’ll have some funds to keep you on your feet.
Seek professional advice when necessary
If you’re unsure where to start with financial planning, or you just want some guidance and a push in the right direction, get help from a professional. This could be an accountant, financial planner, advisor, or broker. These experts are educated and knowledgeable about finance and can help you create a plan that fits your needs.
Of course, make sure the professional you choose is worthwhile. Check out reviews/testimonials, gain insight into their experience and knowledge in the industry, and speak with them before becoming a client to ensure you’re comfortable with how they communicate.
Educate yourself about finances
While experts can help, it’s also a good idea to build up your own financial knowledge. There are dozens of books, videos, and online resources focused on personal finance that teach you everything from how to manage your money, to how to invest, and how to use credit wisely.
You won’t become an expert overnight, but eventually, you’ll know enough to make proper financial decisions.
While debt consolidation is generally a suitable way to reduce your interest rate and streamline your monthly payments, there are some mistakes to watch out for. These include choosing a high-interest option, ignoring hidden fees, or not budgeting properly.
But thankfully, there are several ways to avoid these mistakes, like researching different lenders, always reading the fine print, and going with a payment plan that’s realistic for your situation.
When consolidating your debt, make sure to carefully research the options at your disposal. If you’re unsure if it’s right for you, don’t hesitate to reach out to a professional for assistance.