Debt can overwhelm struggling consumers, whether with piled-up bills or personal loans. According to Banko Sentral ng Pilipinas, consumer debt is surging to 30%, particularly with credit card loans.
One thing’s for sure — anyone into multiple debts would like to get out of them sooner. But can debt consolidation provide another avenue for relief? This article will examine debt consolidation, how it works, and the pros and cons.
What is debt consolidation?
Debt consolidation is a financial strategy that involves merging several debts into one. It aims to simplify the debt repayment process. You combine multiple debts with varying interest rates and payment schedules into a single debt with a lower interest rate and a fixed monthly payment.
There are several methods of consolidating debt, including:
- Balance transfer credit cards
- Personal loans
- Home equity lines of credit (HELOCs)
- Informal loans
Balance transfer
Balance transfer credit cards allow you to transfer your high-interest credit card balances to a new card with a lower interest rate. For example, Security Bank offers a 0% balance transfer for new applications, but cashback and click cards are exempted.
Personal loans
Personal loans may be a good option if you have several different types of debt, such as credit card debt and medical bills. You can consolidate all debts into a single loan with a fixed interest rate and term. The lowest interest you can get is around 1.25% from Metrobank and 1.29% from Citibank.
Home equity line of credit (HELOCS)
HELOCs are secured loans that let you use your home equity to consolidate your debt. This method may be ideal if you have a significant debt and your home has increased in value since you purchased it. Security Bank and Maybank are some of the banks that offer home equity loans.
Informal loans
Informal loans are a common option for many Filipinos who need cash on short notice. These loans are typically made through informal lenders, such as friends, family members, or colleagues, and are often unsecured, meaning they do not involve any collateral from the borrower.
How can debt consolidation help in managing debt?
Accumulated bad debts with high interest rates can wreck your financial goals.
Here are some ways debt consolidation can help.
Lower interest rates and monthly payments
Consolidating your debts into one account may secure a lower interest rate and reduce monthly payments. Say you have two credit cards with outstanding balances of ₱50,000 each, and the interest rates for each card are 24% p.a., respectively.
If you consolidate those debts with a personal loan at a lower interest rate of 10% p.a., you could save ₱14,000 annually in interest charges and reduce your monthly payments from ₱10,334 to just ₱9,167.
The computation above is linear and doesn’t include the processing fees. The example above shows why choosing a lower interest rate can result in savings from the monthly payments.
Simplifies debt management by consolidating multiple debts into one
Instead of paying on different dates, you only need to settle one account per month. It simplifies the process, especially if you simultaneously pay off credit cards, gadget loans, medical bills, and payday loans.
- Credit card debt: ₱30,000 at 24.00% interest p.a.
- Personal loan: ₱40,000 at 15.00% interest p.a.
- Medical bills: ₱20,000 at 10.00% interest p.a.
- Gadget loan: ₱30,000 at 5.00% interest p.a.
If you consolidate these debts into one loan at 12% interest, you would have a total debt of ₱120,000, with an estimated monthly payment of ₱3,734 over 36 months, processing fees excluded.
Allows for a clear repayment plan and timeline
Debt consolidation helps you keep track of your finances and makes you pay on time. With only one creditor to deal with, you focus on paying off debts and avoiding any further financial complications.
You can also budget more effectively. How? You determine how much you must repay each month, allowing you to adjust expenses and income accordingly.
Knowing how much you need to pay each month and when you’ll be debt-free can help you plan for the future and avoid falling back into debt.
Helps improve credit score by making payments on time
Your credit score may improve as you make on-time payments on your consolidated loan. Payment history is one of the most critical factors in determining your credit score.
Additionally, reducing your overall debt load may improve your debt-to-income (DTI) ratio, another important factor in credit scoring. Lenders often look at this when determining whether to approve a loan or credit card application.
For example, many mortgage lenders prefer borrowers to have a DTI of 36% or less.
The DTI ratio is calculated by dividing your total monthly debt payments by your monthly gross income. If you have a monthly income of ₱50,000 and your total monthly debt payments are ₱15,000, your DTI ratio is 30%.
Is debt consolidation always the best solution?
While debt consolidation can be an excellent solution for some, it may not always be the best course of action for everyone. Consider these downsides before signing the dotted line.
High process fees and additional charges on consolidated loans
While you may benefit from a lower interest rate when consolidating debts, be wary of startling loan fees and additional expenses that may lead to an even higher interest rate overall.
Be sure to compare and contrast loan fees to check if consolidation would be beneficial financially.
Risk of using the home as collateral
Banks and lenders provide homeowners with lower interest rates as homeowners use their homes as collateral.
Falling behind on payments can lead to the risk of losing your home. It’s crucial to follow the payment schedule and avoid financial setbacks.
Create a false sense of financial security
Debt consolidation may temporarily relieve overwhelming debt. But it can also create a false sense of financial security.
By reducing monthly payments, you may feel you have more disposable income to spend on other things. This can lead to overspending and further debt accumulation.
Long-term cost
Debt consolidation can extend the life of the debt, resulting in more interest paid over time. Rather than paying off multiple debts individually, consolidating them into one loan can make the debt payment term longer.
You are more likely to have a longer financial commitment since the payment terms are spread out from 36 months to 60 months.
Other debt management strategies
If you have exhausted all means and realized debt consolidation isn’t for you (low chances of getting approved for another loan), check the following options.
- Budgeting: This strategy involves identifying your expenditures and planning to manage your finances efficiently. Start by drafting a budget plan that includes your monthly expenses, debt repayments, and savings goals for the future.
- Negotiating with creditors: Creditors may be willing to negotiate to lower your debt and interest rates if you approach them with a repayment plan. Explain why you are struggling to repay the debt and request a manageable payment plan.
- Seeking credit counseling: A credit counselor and financial planner help assess your income, debt, and budget before recommending how to handle debt successfully. With their guidance, you can create a personalized plan to manage your debts and finances.
Consider using the strategies mentioned and research the loan fees and additional expenses before settling on any debt management strategy.
How to avoid acquiring more debt while consolidating
Dancing your way between borrowing money to pay existing debts can be tricky. Here are some tips on staying on track with consolidation
1. Create a budget plan and stick to it
Create a realistic budget plan considering your income, expenses, and debt obligations. Stick to your budget plan to avoid overspending or missing payments, which can lead to additional interest charges and late fees.
If you plan to consolidate your credit card debts, review your monthly statements to determine how much interest you pay and how much you owe. Use a debt consolidation calculator to estimate how much you could save in interest and monthly payments.
2. Avoid using credit cards or other loans during the process
It can be tempting to continue using credit cards or taking out loans while consolidating your debts. This can lead to acquiring more debt. Pay in cash or use debit cards until you have paid off your consolidated debts.
If you habitually use your credit cards for unnecessary purchases, cut them up, freeze, or lock them to avoid temptation.
3. Be wary of debt consolidation scams
These scams may exploit your desperation to get out of debt and worsen your financial situation. Some scams ask for upfront fees or request your login details, which will compromise your bank and identity information. Others just take your money without providing real solutions.
These predators can also disguise themselves as bank employees via phone calls. Don’t entertain the offers and report the number to your network provider.
Final thoughts
Debt consolidation can help manage your debt by combining existing debt into a single payment. It does potentially reduce interest rates and overall repayment amounts.
Though it may not always be the best solution, other debt management strategies exist, such as budgeting and working with a financial expert. Always be aware of any additional fees or charges that can occur when consolidating your debt and avoid getting into further financial trouble.
To sum it up, finding ways to get out of debt while avoiding getting in more is something many of us face at some point in our lives. Ultimately, it is vital to determine the best strategy for managing your finances and determine what works best for you. Let us know what you think in the comments below.