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    Why Falling Interest Rates Are Perfect For Consolidating Debts

    The COVID-19 pandemic has cast uncertainty and instability over the global economy. 

    In an effort to encourage economic activity, the Federal Reserve has dropped its Fed Funds Rate to a range of 0% - 0.25%. For consumers, this means the bank Prime Rate has decreased to 3.25% (the prime rate is generally 3 percentage points higher than the Fed Fund Rate). 

    This lowered prime rate offers unique opportunities to those who are looking to consolidate any debts they may have, especially if some of the debts carry a high-interest rate.

    Are Interest Rates Falling?

    Yes, interest rates are indeed falling. The last time the Federal Reserve dropped its Fed Funds Rate to nearly 0% was during the economic crisis of 2008-2009. Everything has its price and each price comes with interest. 

    When more people have access to capital it means they’ll use said capital to engage in economically stimulating activities, such as opening up a business, mortgaging a house, or investing in stocks or other investment vehicles.

    A lowered Fed Funds Rate means a lowered bank Prime Rate, which in turn results in lower interest rates for consolidation loans.

    Why Try And Consolidate Now?

    While the Fed Fund Rate doesn’t directly set bank interest rates it’s a major influencing factor. The Fed Funds Rate, the LIBOR Rate, and the Prime Rate all tend to move together, with the Fed Funds Rate leading the charge. 

    With the current Fed rate being almost 0% it’s hard to imagine that consumer interest rates will drop much lower. Even if they did, approval times may increase dramatically if the world economic situation becomes worse.

    At the end of 2015, the Federal Reserve ended its seven-year-long policy of near-zero interest rates. This caused the Prime Rate to increase. Anyone who has taken out a loan of some kind after 2015 likely did so at a higher interest rate than is currently being offered. Because of this, it may be the right time to consolidate debt.

    How Much Can Lower Interest Rates Help?

    Whether one is looking to decrease the overall cost of their loan or simply consolidate their debt to reduce monthly payments, lower interest rates can help quite a bit.

    For example, let's say an individual has $8,000 of debt with an average APR of 14% spread out over credit cards, store cards, and personal loans. If they wanted to pay off the loan over 5 years, it would require a monthly payment of $186.15. The overall interest would amount to $3,168.76, costing the borrower a total of $11,168.76.

    If this individual was able to consolidate their loan down to an APR of 8% paid off over 8 years it would reduce monthly payments to $113.09 with the overall cost of the loan totaling $10,856.97.

    Not only is the overall cost of loan reduced, but monthly payments are as well.

    This can be very helpful to someone whose debt-to-income ratio is very high.

    What Types Of Debt Are Eligible For Consolidation Loans?

    When it comes to debt there are essentially two categories - secured and unsecured. Secured debt is any debt in which collateral was used to guarantee the loan. It can also be used in reference to any loan that’s granted in exchange for something; a mortgage for a house or a car loan for a vehicle. In simple terms, a secured loan means the lender can repossess something from the borrower should they fail to repay.

    An unsecured loan refers to any debt that was extended based on one’s credit history and score. Should a borrower fail to repay the loan, the creditor cannot take anything away from them. Typical examples of unsecured debt include credit cards, store cards, student loans, medical bills, and unsecured personal loans or lines of credit.

    Almost all types of unsecured debt can be consolidated through a consolidation loan. It’s important to note that not all student loans can be consolidated. Some student loans can only be federally refinanced, which rarely reduces the interest rate but may lower payments by extending the term.

    Secured Debt TypesUnsecured Debt Types
    MortgageCredit Cards
    Car LoanMedical Bills
    Title LoanStore/Gas Cards
    Student Loans (some)
    Personal Loans/Lines Of Credit

    What Are The Drawbacks To Consolidating Debt Right Now?

    There aren’t many drawbacks to consolidating outstanding debt balances at the current interest rates. While this is true, those with particularly poor credit may find it difficult to seek out a lender that will allow them to take advantage of the low rates. 

    Even if they receive a slightly lower interest rate, borrowers will need to analyze the overall cost of the loan. Fees and costs associated with an extended payment term may make consolidation more costly than the original loan.

    Are There Alternatives To Debt Consolidation?

    Debt consolidation may not be for everyone. As a general rule of thumb, those whose debt totals 40% or more of their gross income should look at more aggressive debt reduction strategies instead.

    Individuals who are having a very difficult time managing their debt may want to speak to a debt management professional about debt settlement. This is an arbitration process in which the borrower and the creditor agree on a reduced balance that will be regarded as full payment of the loan.

    There are also many balance transfer promotions that can be taken advantage of. For example, many credit cards offer a 6 month 0% interest period on all transferred balances.

    These types of promotions can be very useful in paying down balances as all payments go straight to the principal sum.

    Conclusion

    In response to the COVID-19 pandemic, the Federal Reserve is granting banks access to money at near-zero interest rates. 

    Individuals who have a large amount of high-interest unsecured debt should seriously consider taking advantage of these economically turbulent times by consolidating their debts into a more manageable, lower interest rate loan.