Carrying debts is burdensome for a few reasons, namely that debt is a hassle and it tends to be quite expensive. Many borrowers see whatever balance they originally borrowed grow and grow thanks to interest that just keeps compounding — meaning it often takes longer and is more expensive than originally anticipated to eliminate each debt.
Taking out a debt consolidation loan is one solution to make tackling debt simpler and less costly. However, there are a few things to know about debt consolidation loans before taking one on — like how they work and what it means to add a cosigner to the loan.
How Debt Consolidation Loans Work
It may seem counterintuitive to take on new debt to pay off old debt, but there is a method to what seems like madness at first glance. Borrowers with credit ratings in the ranges of good to excellent — like a 670 or higher on the FICO scale — can often qualify for loans at lower interest rates than they’re paying on credit card balances, as credit cards come with notoriously high average interest rates.
Put simply: If you can qualify for a debt consolidation loan at 10 percent APR, it’s generally less expensive to pay this back than it is to juggle credit card debts with 15-25 percent APR. As an added bonus, it’s usually easier to keep track of making a single loan payment to a single lender at a certain APR than it is to manage multiple credit accounts across multiple issuers, each with its own terms and APR.
Debt consolidation can help people simplify their approach to retiring obligations, but it’s not a magic solution guaranteed to help. For instance, personal loans with long loan terms may result in borrowers having to pay more in interest over time — even if the loan does in fact have a lower APR than the credit card balances. It’s all about doing the math ahead of time to ensure it’s the best time for debt consolidation for you.
Another potential pitfall of consolidation loans is they make it tempting to accrue new credit card debt after seeing that number drop to zero. Basically, consolidation loans can bestow a false sense of being “debt free,” when really it’s very important to budget for loan repayment and avoid racking up new debt in the meantime. The potential downfall here is that borrowers may find themselves in even deeper debt if they take on a consolidation debt and run up their credit card balances once again.
Pros and Cons of Using a Cosigner
Say a borrower believes a debt consolidation loan would help them escape their credit card debt more efficiently — but doesn’t have the strong credit score necessary to qualify for the lowest rates available.
Having someone with strong credit cosign the loan is one possible workaround here. A cosigner agrees to pay the loan if you default, so lenders are more likely to approve applications with cosigners if a primary borrower’s credit isn’t convincing enough on its own.
The cosigner is accepting a lot of risk, as they’re on the hook for the full amount if the first borrower can’t make payments. This means there needs to be a high degree of trust and accountability.
Cosigners can expect the loan to show up on their credit report, too, which means it affects their credit utilization and debt-to-income ratio. This might make it trickier for them to get approved for their own lines of credit until the consolidation loan is paid off.
Adding a cosigner on a consolidation loan is a possible way to get approved if your credit score isn’t strong, but it’s very important for everyone involved to know the risks before agreeing.