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Doing the Math: Why Debt Consolidation Loans May Work for You

Doing the Math: Why Debt Consolidation Loans May Work for You

Now more than ever before, Americans are in debt. Nearly 40% of U.S. households have balances on their credit card, with an average debt of $5,700. Paying off your credit cards is the first step in a healthy financial future. If you are looking to take control of your finances, consider a debt consolidation loan as a way to eliminate credit card debt and establish healthy financial habits.

With a debt consolidation loan, you can pay off all of your debts with a single personal loan. This could include medical bills, balances on credit cards and more. Loan interest rates are determined by your credit history and whether the loan is secured or unsecured, and are usually fixed for the life of the loan. If you are approved for a debt consolidation loan, you’ll make fixed monthly payments for the loan term (usually two to five years). Making a single payment each month may be particularly helpful for anyone who has a hard time keeping up with multiple payments on different debts.

When deciding whether a debt consolidation loan is right for you, it’s critical that you take the time to do the math. Credit cards tend to charge high interest rates, with compounding interest. This means that the interest charges are added to the principal and any accrued interest, and that you’ll ultimately be paying interest on top of interest. For example, if you have a $100 balance on a credit card with a 10% monthly interest rate, you will be charged $10 in interest for the first month. If you don’t pay off the new $110 balance, you will be charged $11 the next month, bringing the total balance to $121. Without charging a dime over the original $100, your debt would continue to grow. Most credit card companies compound interest on a daily basis — meaning that each day that you have a balance, you are being charged interest. This makes it particularly difficult to pay off your credit card balances. Compounding the problems with compounding interest, by making minimum monthly payments on a credit card, it can take you years to finally pay off your debt. Using Credit Karma’s Debt Repayment Calculator, you can calculate exactly how long it will take you to pay off that debt – don’t be shocked if you are going to be paying for more than a decade!

In contrast, most debt consolidation loans use a simple interest formula, which means that interest is charged only on the amount borrowed. These loans are also typically for a fixed term and have a fixed monthly payment. A debt consolidation loan with a lower, simple interest rate will likely result in significant savings — and will help you get back on track financially. Be sure to review the terms of the loan to ensure that the interest is simple, the rate is fixed, and that any origination fee charged will not be too costly. With a fixed interest rate, a simple interest calculation, and a fixed term, debt consolidation loans can save you money — and help you on your way to a healthier financial future!