When you’re saddled with a heavy debt load, it’s natural to seek solutions wherever you can find them. In today’s consumer economy, many Americans end up making huge expenditures on their credit cards, but most consumers don’t think enough about the potential problems associated with the practice of putting off responsibility for today’s purchases until tomorrow.
If you’re looking everywhere for ways to get out of your financial hole, you may have considered using a personal loan to consolidate debt. This approach may or may not be the right choice in your particular circumstances, though. To determine whether or not you should take this tack in your quest to solve financial problems, you’ll need to learn more about the potential benefits and disadvantages of taking out a personal loan and what other steps you can take to improve your monetary situation.
A loan is any type of money that you receive with the stipulation that you will pay it back at a certain point. Examples of loan types include business loans, car loans, and mortgages. Many consumers are only familiar with these popular types of loans that help them with big purchases that they can’t afford outright. Under certain circumstances, however, consumers may also choose to take out personal loans.
Personal loans are similar to other types of loans, but they are given out for different reasons. Technically, personal loans are for any type of expense that doesn’t fall under the purview of a mortgage, auto loan or another common type of loan. However, most banks are highly selective with their procedures for giving out these types of loans. For instance, you can’t usually get one of these types of loans if you simply want more money; you have to present a compelling case to the bank as to why a personal loan is right for you.
One case that the bank might find to be adequately compelling is a dire tale of debt. If you owe a significant amount of money to credit card companies but you demonstrate the ability to pay back money when you borrow it, a bank may be willing to see your side of things and help you out with your situation.
The main reason why you might want to take out a loan for debt consolidation is that the interest rate on your new loan is less than the interest rate on your credit cards. Many credit card companies try to lure customers in with zero percent interest rates, but they might hike these interest rates as high as 20 or 30 percent if people don’t pay back their debt within a certain window. When you take out a loan to pay back what you owe, you’re freed from the interest rates associated with your credit card, and you only have to worry about the interest on your new personal loan.
However, taking out another loan to pay back the rest of your debt isn’t without its inherent risks. When you take out a loan, you’re providing both yourself and the lending body with a type of promise that you’ll take the requisite action to make good on what you owe. Making this sort of decision requires optimism that needs to be realistic; many people in debt would like to think that they have the ability to solve their financial situations, but unless you actually have the wherewithal to make things right, you’ll only be making things worse by taking out a new loan.
Embarking on a new path to solve your financial problems with the help of a bank isn’t a step that you should take lightly, so here are the factors that you’ll need to have lined up before you even consider using a personal loan for debt consolidation purposes.
Talking with a bank about taking out a loan isn’t anything that you should do on a whim, and treading with caution is even more important when you’re taking on debt to help with other money that you owe. Before you sign any paperwork for your new loan, you’ll need to have a detailed plan in place for how you’ll handle your finances from here on out.
Some consumers choose to make full five-year plans for debt consolidation before they consider taking the path of a loan. While it’s most important to imagine where you will be in one year, understanding the long-term effects of your financial choices is the only way to hedge against potential pitfalls. During the planning stages, it can be helpful to break your plan into chunks of incrementally longer periods of time. For instance, you can divide your plan into increments of:
Expenses like groceries and commodities can usually be broken down on a weekly basis. Set a total amount of money that you want to spend a week, including payments on your prospective loan.
Most loans are paid off on a monthly basis. Understand how payments for your new loan would mesh with other common monthly expenses like utility bills, mobile phone costs and rent.
Three months is long enough to see the effects of your new financial perspective in action. Where do you want to be 90 days after you take out your loan?
After six months, the impact of your new spending decisions and loan payments will be coming home to roost. Do you think that you can handle the interest rates of your prospective loan for that long, or do you need to rethink your strategy?
After one year, it’s likely that you will have revolutionized your financial situation with your new loan. If you see any red flags on the horizon for your yearly financial checkup, however, now is the time to nip them in the bud.
Looking at things in a five-year interval really gives you the ability to take in the big picture. After five years, your new loan and spending practices should have totally solved your financial situation, or you should at least be living in a drastically new situation.
You can even break down your spending plans to the level of daily concerns. Are your current daily spending habits in line with your long-term goals? Are there any frivolous expenses that you can cut out now in preparation for your future financial solvency? If you had a hard time with spending today, how do you want tomorrow to look?
If your debt situation is looking really daunting, a personal loan probably isn’t the right idea. These loans are perfect for situations where you owe a moderate amount of money, but they might only make things worse if you have no idea how you’ll ever pay back everything that you owe. In addition, most banks will shy away from consumers who have racked up enormous amounts of debt; if things have really gotten out of hand for you, talking with a credit counselor is probably a better idea. These professionals can help you straighten out your situation and provide you with a realistic plan for getting back on your financial feet.
Taking out a new loan won’t do you any good if your spending isn’t in check. Your spending habits are what got you in this situation in the first place, and if you’re living beyond your means, now is the time to rein things in and give yourself a reality check. A personal loan for debt consolidation isn’t a bandage that you can stick on and then get back to your bad habits; you should view it as more of a once-in-a-lifetime chance to straighten out, fly right and take on a realistic new perspective toward money.
The lower your credit score is, the more interest banks will pile onto your personal loan. If your credit score is low enough, most banks will actually turn you away rather than issue you a loan; they’ll consider you too much of a risk to make any profit off the interest that they plan to charge you. In general, your credit score will need to be above 760 if you want to qualify for single-digit interest rates, and remember that your spouse’s credit score can count against you.
If you can qualify for a new zero-interest credit card, it might be a better choice to transfer your worst debt to this card as long as you can pay off what you owe before high-interest rates kick in.
It’s important to take any potential fees into account as you consider applying for a personal loan. In many cases, banks may lump these fees into the principal of the loan, which means that you’ll have to pay interest on these fees as well. Of course, keep an eye out for high-interest rates; if a bank is charging more than you feel like you can honestly pay, you might need to work with a competing lending agency or totally rethink your plan.
Many financial experts point out that shifting owed money around doesn’t necessarily solve your problems. Even if you take care of all of your credit card debt by getting a new loan, you haven’t actually made any headway on your financial situation, and things could still get worse if you’re unable to pay back your debt at the rate that you expect.
Before you rush into taking out a personal loan, you should keep in mind that other options may be at your disposal as you work to regain your financial solvency. While some of these options may not be applicable in your case, some might be the right way to go if you’re unsure about the advisability of taking on the risk of a new loan.
It can be embarrassing to ask people who are close to you to help out with your financial situation, but taking out a loan with someone you know can sometimes be more advantageous than working with a bank. For instance, someone you know and trust may not feel any need to add an interest rate to your loan, and they may be more flexible in their repayment terms. Plus, if an affluent family member is feeling especially generous, they may even grant you the money you need without any expectation of repayment whatsoever. Things can get complicated, however, if you lose your pride or start feeling different kinds of indebtedness due to the kindness of others.
Most people take out loans on the premise that they will be able to pay them back in full, and you should keep this idea in mind even if you owe more money than you believe you’d ever be able to return. In the free market economy, finances are more fluid than you might think, and if you’re looking for the right way to pay back your money, the time might have come to ask for that promotion or start pursuing a more lucrative line of work. In many cases, seeking to better your financial situation through improved performance requires a lot of effort, but doing so may be a better choice than taking on risky debt.
If you have your spending in check and you increase your income, it’s only a matter of time until you pay back what you owe. Whether you take out a loan or you don’t, you’ll still need to operate on the basis of sound financial principles if you want to avoid finding yourself in another sticky situation a few years down the road. With the right dedication and knowledge, even the most pernicious debt will soon be a thing of the past.
Chris Fuller went to the University of South Florida and has worked in the financial sector for over 20 years. He has extensive experience in all aspects of personal and small business lending, from personal loans, equipment finance to cash flow based solutions for small mom and pop businesses, and large corporations.