Q: When does it make sense to take out a debt consolidation loan?

A: Whenever considering a debt consolidation loan, you have to evaluate the pros and cons and make a rational financial decision.

Typically, you should be looking to pay a lower interest rate on your debt consolidation loan than the composite interest rate of your current outstanding debts. Ideally, you should look for a loan in which the interest rate is lower than any of your current debts.

But you also have to evaluate the costs. If your current debts have different maturities (i.e. one loan that will be paid off in two and a half years, another in three, another in five, and another in seven), then calculating the cost-benefit of a debt consolidation loan becomes trickier. Even with a lower interest rate, a maturity longer than the average maturity of your current loans could result in a higher final payback.

Ultimately, you may decide to pay a higher interest rate if you can stretch your loans out further. If, for example, you had a few three-year and five-year loans at interest rates of 8-15%, you might be willing to pay 16% on one, consolidated ten-year loan. Even though your final payback would be much higher, your monthly payments would be much, much lower, thanks to the longer maturity. Borrowers should be cautious about focusing on the monthly payment instead of the total debt, but in some cases, it is appropriate. You have to educate yourself about all of the pros and cons of a particular loan, and make a rational, informed decision.

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