3 essential questions to answer before you use a personal loan for debt consolidation
Key Takeaways:
A personal loan for debt consolidation only makes sense when it will save you money.
It's not just the interest rate that matters.
Consolidating debt could offer you the opportunity to develop new financial habits.
Life is a series of sometimes frustrating challenges. For example, did you know that it took Thomas Edison at least 1,000 attempts to get the electric lightbulb right, or that Abraham Lincoln ran for political office—and lost—six times before being elected president? As history shows, neither gave up. Instead, they learned from the obstacles they faced and found a path to success.
If you're currently dealing with expensive, high-interest debt, it might feel like a huge obstacle. But now, you have an opportunity to learn from the past and plan for the future with a personal loan for debt consolidation. Taking out a personal loan to consolidate your more costly debts could help you reach your financial goals faster. Before you do, though, ask yourself these three essential questions.
1) Will I be money ahead?
Personal loans are taken out for all kinds of reasons, from home improvement projects to wedding expenses. They're also taken out for the sole purpose of consolidating existing debt. Here's how a debt consolidation loan works:
You apply for a new loan that has better terms than your existing debts.
Once you’re approved, you use the loan funds to pay your other creditors.
You make monthly payments until the new loan is repaid in full.
Ideally, the annual percentage rate (APR) you qualify for on the personal loan is lower than the rate you pay on the outstanding debt.
Here’s an example of what your savings could look like if you move a $15,000 credit card balance at 21% interest to a personal loan at 9% interest.
| Balance | APR | Monthly payment | Months to payoff | Total repaid |
|---|---|---|---|---|---|
High-interest debt | $15,000 | 21% | $375 | 70 | $26,025.29 |
Lower-interest loan | $15,000 | 9% | $373 | 48 | $17,917.23 |
Not everyone can qualify for a 9% APR. But you could save money with a rate higher than 9% if it’s lower than what you’re paying now.
Read more: Personal loan vs credit card debt
2) Can I commit?
Here's where you get to do an honest assessment of your debt situation. Using a personal loan to pay down existing debt works best if you don't take on additional debt. If your debt was caused by a financial emergency but you are otherwise good at living within your budget, you might already be a great candidate for debt consolidation.
If, however, your debt was caused by overspending, it’s important to create a plan to avoid new debt before you take on a new consolidation loan. If you pay off your debts and then rack up more debt while you’re paying off the loan, your financial situation could get worse.
If you can commit to avoiding new debt, several really great things can happen. Here are a few of them:
You'll strengthen your ability to live within a household budget and only spend the money you have available.
You'll gain self-confidence as you realize that you control your budget, not the other way around.
You'll know precisely when the debt is scheduled to be paid off, and you can begin to plan your financial future with confidence in the direction you're headed.
Read more: How and why to consolidate credit card debt
3) What got me here?
Know that you're not alone. Millions (and millions) of us have found ourselves saddled with debt that seemed as though it would never be paid off. And many of us have opted to consolidate that debt as part of a payoff plan.
The big question, the one that propels us toward a greater understanding of finances, is, "What got me here?" For some of us, it's putting our heads in the sand, ignoring debt until it's so big we can no longer pretend it doesn't exist. For others, it's never learning to say no to immediate gratification. Or you might be in the category of folks who ended up in debt because of a financial crisis totally out of their control, such as the death of their wage-earning partner.
Whatever the reason for your current situation, now is a good time to identify it. Once you know how the debt occurred, you can begin to make plans for preventing it, or handling it, in the future.
While a personal loan for debt consolidation won't immediately get you out of debt, it could provide you with the breathing room you need to develop positive financial habits that will serve you well throughout the remainder of your life.
