The average American has a whopping $90,460 in debt. On a generational level, Gen X has the most debt, averaging $135,841 and Gen Z has the least with $9,593.
These numbers include all types of consumer debt products, including student debt, mortgages, personal loans, and credit cards.
While being in debt seems to increasingly be a normal part of American life, being overwhelmed by debt can be incredibly stressful and even debilitating. If you have a number of different debts that are making you feel like your financial situation is an ocean of chaos, you might be thinking about debt consolidation.
What is debt consolidation, though, and how exactly does it work? Let’s take a look at what you need to know to make sure that debt consolidation is the right thing to do before you jump in.
What Is Debt Consolidation?
If you are looking for financial help with your debt, you might consider debt consolidation. It’s important to understand that debt consolidation is not the same thing as debt elimination. You will still be expected to pay back the money that you owe.
When you consolidate your debt, it means that you are combining all of your debts into one larger debt. If you do this correctly, it can lower the interest rates that you are paying on the individual loans and help you pay off your debts more quickly. On top of that, it can simplify things by only having one bill to deal with each month rather than several.
That being said, it’s important to understand that you are not always guaranteed a lower interest rate when you consolidate your debt. You will also want to understand that you are lower monthly payments will likely mean that you will have an extended repayment term. There can also be a number of fees for debt consolidation loans such as fees for the balance transfer, loan set up, closing costs, and annual fees.
How Does Debt Consolidation Work?
There are a number of different debt consolidation loans available. Depending on the type of loan you get, the process can be a bit different. In general, however, it typically looks something like this:
- You fill out a debt consolidation loan application
- The lender checks your debt to income ratio and your credit
- You get the lender a bunch of documentation about your identity, debt, mortgage, finances, insurances, and more
- You are evaluated by the lender
- You are either approved or rejected for the loan
In some instances, your lender might actually pay off your debts and you begin a brand-new loan to the lender. Other times, you receive a line of credit or money that can be used to pay off your debts on your own.
How to Consolidate Debt: The Different Options
When it comes to debt consolidation, you have a number of different options. Some of these loans are secured and some of them are unsecured.
Secured loans are loans where you have put up one of your assets as collateral. This might mean using your home or your car as collateral. This can be a very risky thing to do, as it means that the company can come after the asset you listed as collateral if you miss payments.
On the other hand, unsecured loans don’t have any of your assets as collateral. While that might seem awesome, it also means that the interest rate will be much higher because it’s a higher risk for the loan company.
Credit Card Balance Transfer
One way that people consolidate their debt is through credit card balance transfers. This is where you transfer all of your credit card debt you a brand-new credit card.
This might mean a number of transfer fees and conditions including a spike in the interest rate if you miss a payment. Some credit cards offer introductory offers of low interest-rate balance transfers for a period of time. It is very important to read all of the fine print, however, as the interest rate can be very high when that introductory period is over.
Debt Consolidation Loan
Depending on the terms of the loan, debt consolidation loans can be either unsecured or secured. They can come from a peer-to-peer lender or from a bank.
Student Loan Consolidation
For people who have federal student loans, there is student loan consolidation. This can roll all of a person’s student loans into one payment. For people who have private student loans, something they might consider is refinancing if they’re interested in consolidating the loans.
Another option for debt consolidation are personal loans. The terms of this type of loan can vary widely depending on your lender and your personal financial information.
Home Equity Line of Credit (HELOC)
Another way that some people consolidate their debt is with a home equity line of credit (HELOC). This is a secured loan that allows homeowners to borrow money against the value of their property. The collateral is the equity that the homeowner has built up in the house.
When you do this, you are pretty much giving up the portion of the house that you actually own and return for another loan. While this might seem silly, this type of loan typically has a much lower interest rate than credit cards or other personal loans. For this reason, people can save money on interest over time by using a HELOC to consolidate their debt.
How Do You Know If Debt Consolidation Is Right For You?
It’s important to understand that debt consolidation isn’t always the best idea. While it can be a great way to make a plan for the future of your finances and get on top of your payments, it does not guarantee that you will become debt free.
It is essential that you take a look at your spending habits and make sure they are in check before you consider debt consolidation. You also want to take a look at your credit score and ensure that you are making your current payments on time.
You want to realistically look at how quickly you can pay off your balances when thinking about that consolidation. If you will be able to pay off your debt within the next year or year and a half at your current pace, it might not be worth the trouble of debt consolidation.
If the amount of debt that you have is overwhelming or amounts to more than half your income, you might consider looking into debt relief options rather than debt consolidation options.
All that being said, there are a few things that indicate that debt consolidation could be a good choice for you. Some of these include:
- You have a high enough income to make your existing payments on time and your credit score is good enough that you can qualify for a fixed-rate loan or a low-interest credit card
- Your debts amount to less than half of your income
It’s essential that you are sticking to a financial plan or a budget that prioritizes making your monthly payments on time if you are committed to getting the most out of debt consolidation.
Americans and Debt: The New Normal
For many Americans, the biggest source of debt comes in the form of a mortgage loan. Gen X has the highest average balance when it comes to their mortgage at $238,344. The second-highest average goes to millennials at $224,500.
Gen X also gets the prize for the highest balances on credit cards. Their average credit card debt is $8,215. Their auto loans are also the highest, at $21,570.
If all that isn’t enough, the highest amount of student loan debt also goes to Gen X, along with the highest average of HELOCs. On the flip side, they have the lowest personal loans, the highest average of which goes to the baby boomers.
Does Debt Consolidation Make Sense For You?
As you can see, debt consolidation is not necessarily the answer to every American’s financial issues. However, it can be a useful financial tool when you understand how it works, what it means, and how it can be useful. It’s important to take a look at your own personal financial situation to determine whether or not that consolidation would improve your financial situation or simply make it worse.
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