Okay, so you’re considering consolidating your debt, but you’re not sure exactly what that means. Don’t worry, we’ve got your back.
Debt consolidation is a popular way to get out of debt. The idea is, you take all your debts and combine them into a single loan and payment, usually at a lower interest rate than the original debts. It can be a great option for some people, but it’s also important to consider multiple debt-relief options when navigating your way out of debt.
What is debt consolidation?
Debt consolidation is a process of taking out one new loan to pay off several existing loans or debts. If you’re able to qualify for lower interest rates than the multiple debts you had previously, such as credit cards, debt consolidation can help save you money.
Okay, so how does debt consolidation work?
You can benefit from debt consolidation by taking your various debts and consolidating them into one monthly payment. However, the best debt consolidation loans are typically only available to those with good credit scores. If you don’t have great credit, you may have higher interest rates, be approved for a loan that’s smaller than what you need, or be required to put up collateral to back the loan. Debt consolidation loans are also subject to origination fees that will add on to your overall debt.
Another thing to consider is your monthly payment amount. The monthly payment on a debt consolidation loan will likely be greater than paying the minimum payment on your outstanding accounts. So, if you’re struggling to make your current monthly payment amounts, debt consolidation is likely not the best option for you.
What’s the difference between debt consolidation and debt settlement?
Debt consolidation is when you take your various debts and combine them into one larger loan (see below for how this works). Debt settlement is when an agreement is reached with a creditor to reduce the amount you’re required to pay them. In other words, it’s a way to resolve your debt for less than what you currently owe. If you have a hard time keeping up with your monthly debt payments or cannot afford to pay back what you owe, it’s worth considering debt settlement as an option.
What’s the fastest way to get out of debt?
The quicker you can get out of debt, the better, obviously. The best way to do this is by reaching a repayment agreement with your creditors. In a debt settlement agreement, your creditor agrees to let you resolve your debt to them for less than you owe. This is a win-win because creditors receive a portion of the debt back quicker and consumers get out of debt while paying less than what they owe.
Can a debt consolidation affect my credit?
While debt consolidation can help you, it also has the potential to negatively impact your credit score. To see if you qualify for a debt consolidation loan, lenders will perform a credit pull that can also negatively impact your score.
What are the most common ways to consolidate debt?
When you consolidate your debt, it generally means that you’re taking multiple outstanding debts and reorganizing them into one new loan, usually with a lower interest rate than the previous debts. Then you pay back the lender in a single monthly payment rather than continuing to make multiple payments to various creditors. Here are some ways to do this:
– Balance transfer card: A balance transfer card is a credit card that can be used to transfer the amount of debt you owe on another card or multiple cards. With this option there is a transfer fee, which is a percent of your total balance. You might also be responsible for paying back additional interest if you don’t pay off the full amount after the promotional period.
– Credit card consolidation loan: A credit card consolidation loan allows you to borrow a lump sum and repay it over time. It’s important to know that there is an origination fee with this type of loan. These loans can also be more challenging to qualify for since they’re based on your credit score.
– Home equity loan or line of credit (HELOC): A home equity loan uses your home as collateral, allowing you to pay off your debt by giving you a lump sum, which you then repay over time. Since you’re using your home to back the loan, defaulting on this type of loan could put your home in jeopardy.
– 401(k) loan: This is an option that can help you pay off your debt by borrowing from your retirement savings. This type of loan can offer more favorable repayment terms for short-term loans since you’re essentially borrowing from yourself. However, if you’re not confident that you can pay back the money within the repayment period, you could be subject to hefty fees.
– Refinance your house: When you’re struggling to make your mortgage payments, a rate and term refinance can help divert more money toward your debt without changing the principal balance. This could allow you to better manage your finances and pay down debt.
Alternatives to Debt Consolidation
The primary alternative we recommend is called debt settlement. Debt settlement is a process of resolving delinquent debt through an agreement with creditors to reduce the amount owed. This option will ultimately allow you to pay less money than you owe and help you get back on the path to financial freedom, quicker. Debt settlement companies can provide options for affordable monthly payments, which in the long run could save you more money.
A debt management counselor can also be a good way to tackle debt. Credit management counselors review your debt situation to see if you are eligible for a debt management program and they can negotiate lower interest rates with creditors. You could save money on interest and fees with credit counseling, but you may also be labeled a high-risk borrower in the future. Credit counseling and debt management programs also do not reduce the amount you’re required to pay — in fact, their fees will add to this amount.
The two main types of bankruptcy for individuals are Chapter 7 and Chapter 13. Chapter 7 bankruptcy is for those who are unable to pay debts. Personal assets are liquidated and used to pay off outstanding debts. The remaining debts might be forgiven.
Chapter 13 allows individuals to keep assets that they may not be allowed in Chapter 7 bankruptcy. Chapter 13 plans can be seen as a way of restructuring debt, allowing people to repay their debts over five years, according to current guidelines, without declaring personal bankruptcy.
The biggest drawback to any type of bankruptcy is that it can negatively affect your credit score and financing opportunities for years to come. Bankruptcy also carries additional fees. Depending on your situation, these additional fees can vary greatly.
If you own a home, with plenty of equity built up (meaning, the difference between what you owe on the loan, and what you have paid), you could consider refinancing your mortgage for cash-out. This approach involves taking out a new home loan that is larger than your current one, and you receive the difference as cash. You can then use these funds to pay off your existing debts. While this might sound like a good idea, if you do not have the discipline or means to keep up with these payments, you would be putting your home at risk. It’s best to speak with a certified debt consultant before taking this step as it can have major implications for the rest of your financial life.
Now the real question: Is debt consolidation right for you?
It’s important to know how debt relief works, and which type will be best for your situation. Consolidating debt might be a good option for those with high credit scores, or those trying to work themselves back toward good standing—but debt settlement can allow you to resolve your debt more quickly, which will also bring you back to good standing. Our expert debt counselors can help find the perfect debt-relief option for you.
If you’re considering debt consolidation, we hope this blog post has been helpful. If your goal is to find the most affordable way to get out of debt, we recommend speaking with one of our certified debt consultants today so they can walk you through all the options available to help you get out from under your pile of credit card bills. With the help of a debt consultant, it’s possible for you to resolve your debt in as little as 24–36 months.
A Few More Common Debt Consolidation Questions:
Do consolidation loans hurt my credit score?
Debt consolidation can impact your credit score through what’s known as a hard inquiry, lower credit utilization, and closure of accounts. These impacts may not be permanent and vary from person to person, but they could limit the ability to get loans in the future.
Is debt consolidation a good idea?
This is a tricky question, and there are many factors to consider. Debt consolidation might be a good idea if you have good credit and can qualify for favorable loan terms. But if you can’t afford to pay off what you owe, debt settlement can help reduce what you’re required to pay back and resolve your debt in as little as 24–36 months.
What’s the smartest way to consolidate debt?
The smartest way to consolidate your debt is to review all your options and find the debt-relief option that works best for your situation. Speaking to a certified debt consultant can help you find the right option for you.
What are the disadvantages of consolidation?
The main disadvantages of debt consolidation are that the fees can add to your debt and it doesn’t reduce the principal amount that you owe. Your monthly payment amount could also increase if you’re currently used to paying the minimum monthly payment on your accounts. If you’re looking to reduce what you’re required to pay back, debt settlement might be a better option for you.
How do I qualify for debt consolidation?
The criteria for qualifying borrowers can vary from lender to lender. Common requirements for borrowers are that they be at least 18 years old, a legal resident of the U.S., and not in foreclosure or bankruptcy. Most lenders look at your credit score—it should be over 600 points with a debt-to-income ratio below 45% to qualify for favorable terms. If you don’t have great credit, debt consolidation might not be the best option for you.
How can I get all my debt into one payment?
To get all of your debt into a single payment, you should take the first step of speaking with an expert debt consultant to help find the debt-relief plan that best fits your situation. Typically debt consolidation and debt settlement will both result in you making a single payment. Debt settlement can also provide you the option of becoming debt-free by only paying a fraction of what you owe.
How can I get out of debt without paying anything?
Getting entirely out of debt without paying a thing is not a realistic solution. The next best option is to pay less than what you owe through a debt settlement program. A debt settlement company can help negotiate with your creditors to reduce the total amount that you owe and help you resolve your debts in as little as 24–36 months.
How do I choose the right debt consolidation loan?
Choosing the right debt consolidation loan can be tricky. You’ll want to choose a loan that offers the best interest rate and has flexible repayment options. Be sure to shop around to find the best possible deal. It’s important to note that qualification and financing terms for these loans are based on your credit score. If you don’t have good credit, you might not qualify for the best debt consolidation loan.