Consolidating debt involves taking out one loan with the intent to pay off multiple debts. People consolidate debts for two distinct reasons: either to lower their monthly payment or to lower their long-term interest payments. When you consolidate to lower your payments, you usually end up paying back more in the long run because you stretch out your payment schedule.
Consolidating Debt Using Credit Card Balance Transfers
Consolidating debt using a credit-card balance transfer is a popular option for debt consolidation. Credit card companies try to entice customers to transfer balances by offering special introductory rates, sometimes as low as offering no interest for six months to a year for balances transferred. Some companies also offer low promotional rates (typically 1.99 percent to 5 percent) for a longer period of time, or even for the life of the balance. Many balance transfers have a fee associated with them- usually 3 percent of the amount transferred, although there is usually an upper limit (cap) on the fee. When using credit cards to transfer balances, be aware that as of August 2009 in the U.S., payments are applied to lower interest rates first., which means that if you use that credit card to make a standard purchase, any payments you make will first go towards paying off the balance transfer debt rather than the new debt. You will thus be charged interest on the standard purchase at the standard rate, for the time it takes you to pay off your balance transfer, until you are able to make a payment that is applied to the purchase at the higher interest rate. However, laws are in the works, as of August 2009, to alter that practice.
Consolidating Debt Using A Personal Loan
You can also consolidate debt using a personal loan from a bank or credit union. A higher interest rate is usually associated with personal loans than with credit-card balance transfers. However, the benefit of a personal loan is that the interest rate is generally set and does not expire or go up after a special promotional period ends. To consolidate loans using this method, you need to apply for a loan at your bank or credit union of choice. Some banks offer special debt-consolidation loans just for this purpose.
Consolidating Debt into a Home Loan
Some people recommend taking a second mortgage or a home equity line of credit in order to consolidate debt. Using that method, you use the equity of your home to pay off other debt, and you then have only one payment -- the mortgage payment (or two payments if you selected a mortgage and home equity line of credit). Mortgages and home equity lines of credit usually have lower interest rates then personal loans. In addition, mortgage interest is usually tax deductible up to a certain level. However, consolidating debt by using a mortgage loan or home equity loan can be risky. Mortgage debt is secured debt, while credit card debt is unsecured debt. That means that if you fail to make your payments , the bank can take your home. Typically, credit card companies cannot take your home for failure to pay credit card debt.
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