Good or Bad Idea…?

I recently received a query from someone which was –

“I am struggling to manage the high credit card debt because of multiple credit cards. Apparently, I got to know about paying it off through personal loan. I liked the idea as I was feeling little overwhelmed by different credit cards, tracking their due dates and payments. But I want to know whether this is good option to go with or not?”

Sounds simple – isn’t it?

But is it that simple? Let’s analyze this a little further.

What is debt Consolidation?

Debt consolidation is a tool which converts multiple debt payments into a single, lower payment. In other words, it’s a kind of debt refinancing which helps you to pay off other debt.

Use of a credit card for buying is easy and not new to anyone. People often prefer to transact on credit cards instead of cash/debit card as it offers convenience to repay in small amount (remember minimum balance due) over long term. But using credit cards often and for high purchase amount can increase your debt burden. Also, if you are having multiple credit cards then managing and paying off dues in time could be tiring.  

There are many ways to consolidate debt like transferring the debt from one credit card to another (balance transfer), taking debt consolidation loan from your bank (if bank offers) or by taking personal loan. Many people choose to take personal loan for paying off their credit card debt because they may get it at lower rate.

Before opting for personal loan, one should try following options like –

• Changing the spending habits which can help save more.
• Accumulate savings to pay off the credit card loan.
• Getting information about ‘Debt consolidation loan plan’ from your bank or other bank to transfer credit card outstanding with their interest rate.

This will help to compare and go for the best deal.

If none of the above options works out, then go with personal loan that offers lowest rate. The option of going with personal loan to clear / consolidate credit card debt could be a good alternative because credit card rates are generally high.

But every option comes with its own pros and cons and so is this option. Let’s understand them before we jump to a conclusion:

Pros

1. Personal loan is cheaper than credit card loan. Credit card loan is also known as revolving debt because your card limit keeps increasing with more spending. It can ultimately go to increase your debt burden. Therefore, this burden can be reduced by using personal loan.
2. Managing multiple credit cards, their payments, keeping track of due dates is a cumbersome task. This whole process can be simplified to a single monthly payment by opting for personal loan.
3. Personal loan allows more time for loan repayment which helps you to manage your debt effectively.
4. Your credit score doesn’t get affected by this debt consolidation. Rather new personal loan could help rebuild it.

Cons

1. The interest rate on personal loan is not fixed and depends on your credit score, amount of loan, credit history etc. If you are getting personal loan at low interest rate as compared to credit card by minimum 2% then it makes some sense to go forward.
2. You should also take into consideration your current debt situation, your ability to repay personal loan in given time, terms related to personal loan and penalties in case of prepayment.
3. Even though the payments will be low, but it is for long time, which means you will be in debt for that long.
4. Consolidation of debt is just a way to reduce burden and manage it effectively. Your debt will still be counted as debt.

Debt consolidation does not guarantee that you will be debt free or you can spend more on credit cards. But it all depends on how you take benefit of this method and pay off your debt. Many a times people still get stuck in the debt trap even after debt consolidation and reason is -poor spending habits and mistaken behavior towards saving.

Taking calculated risk as per your financial situation could definitely help to come out of the debt burden and live life debt free!