Debt Consolidation
Debt consolidation loans help you pay off multiple high-interest debts, consolidating your loans into a single payment. A debt consolidation loan can provide debt relief by simplifying your finances and combining multiple high-interest debts into a single payment each month. Get started on your debt consolidation loan today! Call Today!
What is a Debt Consolidation ?
Debt consolidation, also known as credit consolidation, is when you refinance multiple existing loans or debts into one new loan. Essentially, you get to pay off all your different lenders and have a large loan with only one lender instead.
There are many reasons someone might consider debt consolidation. It can potentially lower your monthly payment (by extending your repayment period), help you secure an overall lower-interest loan and simplify your finances. Understanding these benefits can help you determine if debt consolidation is right for you.
How does debt consolidation work?
There are several ways to consolidate debt, but the general process entails taking out a new debt — in this case, a personal loan — to pay off multiple debts and streamline the repayment process. Borrowing a home equity loan or taking out a balance transfer credit card are also methods of debt consolidation.
However, a debt consolidation loan is one of the most common and easiest ways to consolidate debt. With fixed interest rates and monthly payments, it’s possible to save money over the life of your loan by securing a lower rate than what you had on your previous debts.
Plus, a debt consolidation loan is an unsecured debt, meaning you don’t need to secure the loan with collateral and run the risk of losing your assets, like your home, if you’re unable to make the monthly payments. If debt consolidation isn’t an option, working with a credit counseling agency to establish a debt management plan may be a better way of dealing with your debt.
What is a Debt Consolidation Loan?
A debt consolidation loan can be taken to repay many high-interest debts with one new low-interest loan. It is a strategy of simplifying finances for those consumers who are dealing with several unsecured debts like credit cards, medical bills, or personal loans. Consumers wind up their unsecured debts into one single bill and use the consolidation loan to repay the total amount owed. Several financial institutions offer debt consolidation loans to borrowers who have trouble managing the number or size of their outstanding debts.
How to Apply for debt consolidation
- Research lenders: Consider the types of loans and interest rates lenders may offer you. They typically look at factors like credit score, income, current debts and debt-to-income (DTI) ratio. To find personalized loan offers based on your credit history without affecting your credit score, check out LendingTree’s personal loan marketplace.
- Apply for prequalification: Prequalify for a loan by submitting details to lenders like your income, debts and credit history. They’ll conduct a soft credit inquiry – which doesn’t affect your credit score – to determine whether you’d likely qualify, and for what terms. Prequalification doesn’t guarantee loan approval but is a great way to research terms you could see with a lender.
- Compare offers: Compare loan offers by looking at each offer’s APR and other terms, as well as fees. Personal loans often come with origination fees that range from 1% to 8% of the amount owed, and some also come with late payment fees and prepayment penalties.
- Choose a lender and submit a formal application: Once you’ve picked a lender, gather necessary documents, like proof of income, income and other forms of debts. Before they formally approve you, lenders will do a hard credit check.
- Start paying off existing debt: If you’re approved, your lender will deposit the entire loan amount into your bank account so you can begin paying off your debts. Stick to your monthly payments to avoid late payments (and fees) that might damage your credit.
Benefits of debt consolidation
There are many benefits of debt consolidation, including:
- Saving money: The biggest perk of debt consolidation for most people is saving money. You can save significant money in interest by consolidating multiple high-interest debts into a single lower-interest loan or credit card.
- Simplifying payments: Managing multiple debt payments each month can be a challenge. And it can lead to late or missed payments, which negatively impact your credit score. Streamlining multiple monthly payments into one makes managing debt much easier and can help boost your credit score.
- Well-defined repayment term: Some debts, especially credit cards that aren’t on a fixed payment schedule, can linger for years until you pay them off. But the right debt consolidation loan will put debt repayment on a fixed schedule. That means you’ll know down to the day when your loan will be repaid in full.
- Less stress: Managing one debt instead of many can remove many stressful financial interactions each month. Plus, knowing you’ve locked in a lower interest rate and will be saving money can reduce stress too.
Types of Debt Consolidation
debt consolidation can be a way to manage multiple types of debt, there are several types of debt consolidation. Here are the different types of debt consolidation to meet individual borrower needs:
Debt Consolidation Loan
A debt consolidation loan is a lower interest personal loan that allows you to move multiple credit card balances or loans into one account. Since these loans are unsecured, they typically require a good credit score to receive the lowest interest rates.
Borrowers looking for a debt consolidation loan with bad credit may still be able to qualify, just for a slightly higher interest rate. That’s why it makes sense to shop around with various lenders to get the best price before committing.
Credit card balance transfer
A credit card balance transfer makes sense for borrowers with good or excellent credit scores (above 690 on the FICO scale). That’s because these borrowers may qualify for a 0% APR credit card for a set period. And that period can be incredibly valuable in repaying debt without additional interest piling on.
But borrowers with poor credit may still find a balance transfer card useful. Streamlining multiple credit cards into a single payment makes sense as long as the interest rate on the new card is lower than the average of existing debts.
Home equity loan and HELOC
A home equity loan and home equity line of credit (HELOC) are secured loans where your home is the collateral. This means you’re borrowing money against the equity in your home, and that typically comes at a lower interest rate than other loan options.
Debt consolidation using a home equity loan can be a smart move when you have considerable equity in your home and are committed to repaying debt. However, those struggling with overspending could put their home at risk if the loan isn’t repaid timely.
401(k) Loans
Typically, taking out a loan using a retirement account, like a 401(k), is a financial no-no. But in the case of debt consolidation, when you can commit to repaying the balance plus interest quickly, it may be worth a look.
401(k) loans generally have a low interest rate, plus you’ll be repaying the loan plus interest to yourself (less any fees from your 401(k) provider, of course). However, the major downside of taking a 401(k) loan is that it can derail your retirement savings plan. Add that to potential tax consequences and fees, and you’ll see that it’s probably best to review this loan option with a financial professional before you use a 401(k) loan for debt consolidation.
Savings / CD Loans
A Certificate of Deposit (CD) is a savings vehicle that you commit to leaving money in the account at a set interest rate for a specified period. You can, however, take out a CD loan against that money, whereas the CD acts as collateral to secure a personal loan.
Using a CD loan for debt consolidation is a way to leverage that money without facing early withdrawal penalties. But not all banks offer CD loans, and you have to have an active CD to qualify.
Student Loan Consolidation
Depending on the types of student loans you have, federal or private, the debt consolidation options look different. For example, you may lock in a longer repayment term for federal loans, which lowers monthly payments, but generally, you won’t receive a lower interest rate.
With private student loans, you can shop around to consolidate multiple loans into a single loan at a better interest rate. And that can result in pretty significant interest savings, especially if your loan balance is high.
Cash-Out Refinance
You can roll multiple debts into a cash-out refinance as another type of debt consolidation. With a cash-out refinance, you’ll replace your existing mortgage with one whose higher balance reflects the debt you’ve added on.
Since a cash-out refinance means taking out a new mortgage, there are closing costs and fees to consider. So you’ll need to calculate the interest savings from debt consolidation plus these costs before pursuing this option.
How To Consolidate Debt
There are several different ways to consolidate debt:
- Debt consolidation loans. Debt consolidation loans are a type of personal loan available through banks, credit unions and online lenders. With this type of loan, lenders may pay off your debt directly or provide the cash for the borrower to pay off their outstanding balances.
- Personal loans. With a personal loan used for debt consolidation, you take out a new loan from a bank, credit union or another lender to pay off higher-interest debts, such as credit card debts or other bills.
- Balance transfer credit card. If you have good enough credit, you can transfer the balance of several credit cards to a new balance transfer credit card at a lower interest rate, sometimes at 0% APR for an introductory period.
- Home equity loan. If you own your home and have built up enough equity to qualify, you may be able to use a home equity loan or home equity line of credit (HELOC) to consolidate your debt at a lower interest rate.
- Cash-out mortgage refinance. A cash-out mortgage refinance gives you the option to refinance your home for more than the outstanding balance. You can use the difference in cash to pay off outstanding debts.
How to decide if you should consolidate your debt
The answer to this question depends on your circumstances. That said, here are some scenarios where you might be a good candidate:
- You have a good credit score: If you have a good credit score — at least 670 — you’ll have a better chance of securing a lower interest rate than you have on your current debt, which could save you money.
- You prefer fixed payments: If you prefer your interest rate, repayment term and monthly payment to be fixed, a debt consolidation loan might be right for you.
- You want one monthly payment: Also, taking out a debt consolidation loan could be a good idea if you don’t like keeping track of multiple payments.
- You can afford to repay the loan: Finally, a debt consolidation loan will only benefit you if you can afford to repay it. You’ll risk digging into a deeper financial hole if you can’t.
When is debt consolidation a good or bad idea?
There’s no one-size-fits-all debt management strategy.
To determine if debt consolidation is a good idea, you’ll need to take a close look at your finances.
Debt consolidation is a good idea when…
- You can qualify for a lower APR than what you’re currently paying on your debts
- You’re struggling to manage credit card bills and loan payments
- You want to pay off debt faster on a set schedule
Debt consolidation is a bad idea when…
- You can’t qualify for a lower APR than what you’re currently paying on your debts
- You only have small balances that you can pay off quickly
- You owe too much to manage and repay
When debt consolidation is not a smart move?
Debt consolidation may not be a smart move for everyone. It’s smart to consult with a financial professional or explore other options if you:
- Haven’t yet changed the spending habits that got you into debt in the first place
- Have debt that can be repaid in less than a year
- Are working to improve a poor credit score
Debt Consolidation vs. Debt Settlement
The terms debt consolidation and debt settlement are often used interchangeably—but there are some important differences. Most significantly, debt settlement involves hiring and paying a third-party company to negotiate a lump-sum payment that each of your creditors will accept in lieu of paying the total outstanding balance. These settlement companies typically charge a fee between 15% and 20% of the total debt amount and are often a scam.
In contrast, debt consolidation requires the borrower to pay their full debt balances using funds from a new loan. Unless there are origination fees or other administrative fees, borrowers don’t have to pay anyone to complete the consolidation process. Instead, the debt consolidation process requires borrowers to take inventory of their debts and develop a plan to pay them off in a more streamlined—often less expensive—way.
Debt consolidation pros and cons
Debt consolidation has both benefits and drawbacks to consider before you make a final decision.
Pros of Debt Consolidation
- Easier to manage your expenses by combining multiple debts into a single monthly payment.
- Possible lower interest rate
- Could lower your overall monthly debt payment
Cons of Debt Consolidation
- May not qualify for an interest rate that’s lower than your existing balances
- Lengthened repayment term could cost more in interest even with a lower rate
- Some loans require you to put your home up as collateral
How does debt consolidation hurt your credit?
Debt consolidation often involves taking out a new loan or credit card to pay off existing debt. In general, taking on any kind of new debt to help pay off old ones will lower your credit score, even if temporarily.
These approaches in particular require a hard credit check during the formal application process, which hurts your credit score. And while the effect is often short-lived, a hard credit check might leave a larger credit ding if you have other large debts or a history of late payments.
Here are examples of how paying off debt can hurt your credit score:
- Triggering a hard credit inquiry: Applying for a new loan or line or credit leads to a temporary dip in your credit score because lenders do a hard credit inquiry during the formal approval process. Applying for one type of loan will affect your score less than applying for different forms of financial help at once. On average, hard inquiries will take a few points off your score. This dip will likely disappear as you consolidate debt and rebuild credit. You can expect hard inquiries to stay on your report for about two years.
- Closing out credit cards: It may be tempting to close credit card accounts after paying them off, but this lowers your total available credit and reduces the length of your credit history. All affect your credit score. Consider leaving your oldest accounts open, as well as the ones with the largest credit limits.
- Using a debt management plan: A nonprofit credit counseling agency may be able to create a streamlined plan to help you pay back debt. This often means closing your credit cards, which can cause your score to dip. Expect it to climb as debts get paid off on time, however.
- Making late payments: Your debt payment history accounts for 35% of your credit score, so it affects your credit more than any other factor. Keep making timely payments on your accounts to prevent your score from dropping.
How does debt consolidation help your credit?
Debt consolidation can boost your credit in huge ways. For example, using a personal loan or home equity loan to pay off credit card debt means you might be able to pay off your balance faster and save on interest payments. That’s because both loan types typically come with lower interest rates – especially if you have excellent credit.
Here’s more on how debt consolidation may help your credit:
- Improves your credit history: With debt consolidation strategies you’re more likely to make timely payments and in turn raise your credit score. Paying more than the minimum you owe every month might boost your score further.
- Reduces your credit utilization ratio: Paying off credit card debts with a consolidation loan frees up your available credit and reduces your credit utilization ratio. This number compares how much debt you carry to your credit limit; ideally you want to keep it at or below 30%.
- Improves your credit mix: If you only carry a few types of debt, diversifying the mix with a consolidation loan might actually increase your credit score. That’s because lenders see you as a responsible borrower who can successfully juggle different kinds of debt.
Alternatives to Debt Consolidation
If you don’t want to take out a new loan, open a credit card or tap your home equity to consolidate debt, there are a several other alternatives:
- Pay off debts on your own. If your debt payments are manageable, you can make a plan to pay off debt faster. If you have sufficient income and room in your monthly budget, you may be able to pay off your debts fast without debt consolidation, using the debt snowball or debt avalanche method.
- Enter into a debt management program (DMP). If you are having trouble paying your bills, you can work with a nonprofit consumer credit counseling agency to set up a debt management program where you agree to pay off your debts with one monthly payment to the credit counseling agency, which then pays your creditors for you.
- File for bankruptcy. If you’re struggling to pay your bills, you don’t want (or cannot get approved) to borrow any more money and you don’t believe you will be able to repay your debts, you may want to consider declaring bankruptcy. This legal process can wipe out some or all of your debts and help you make a fresh start. But be aware that bankruptcy stays on your credit report for seven to 10 years.
- Consider debt settlement, but as a last resort. If you have fallen behind on your debts, you may consider negotiating with your creditors to accept a smaller amount of money than what you owe. This is called debt settlement, and you can do it yourself or by working with a debt settlement company. But be cautious. Debt settlement can be risky. Creditors are not required to accept your debt settlement offer and may not want to negotiate. And the debt settlement process typically causes significant damage to your credit. It should be considered only as a last resort.
How do you choose the right debt consolidation loan?
Debt consolidation loans are not one-size-fits-all. When deciding which is the right one for you, it’s important to consider two things: your credit score and the type of debt you want to pay off.
If most of your debts are secured, such as an auto loan or a mortgage. Then, the best course of action is to look for a refinance loan. If you’re looking to consolidate unsecured debts, like personal loans, student loans or medical bills, then the best route is to take out a consolidation loan.
And obviously you’re going to be looking for an interest rate lower than the ones you are currently paying. If the new interest rate isn’t fixed, be sure to talk to the lender about the possibility that it might increase down the line and budget accordingly. And no matter what, read the fine print. Every last tiny line of it.
Tips for consolidating debt
Keep these tips in mind when consolidating debt:
- Do your research. Make sure you compare costs, get quotes and explore all your options. You want to secure the best rate so you’re saving as much money as possible.
- Review your income and credit. Lenders will look at these factors and use them to determine what kinds of options you qualify for. If your income is too low or your credit is poor, you may not be eligible for the debt consolidation option you’re hoping for.
- Gather the necessary documentation. Potential lenders will require supporting documents, such as proof of employment, as a part of your application.
- Decide on your plan for debt consolidation. You’ll want to have a plan for how you’ll deal with your lenders. For example, you might want to decide if you’re going to close all the accounts or keep some open (without incurring new debt, of course).
- Make sure debt consolidation is right for you. Lastly, make sure you evaluate whether this is the best option for you. Ensure that, for your situation, the benefits outweigh the drawbacks.
How do you choose the right debt consolidation company?
There are plenty of companies that exist just to take advantage of people struggling with debt — you want to avoid these companies at all costs.
For a loan or a balance transfer credit card, use a licensed financial institution and a name you trust. If you decide a debt management plan or a debt settlement is right for you, vet the debt relief company or agency in question through the Better Business Bureau to see if any complaints have been made against them.
Lastly, you’ll want to choose a company that can give you the right solution that adjusts to your monthly budgeting and to the timeframe you’ve established to pay off your debts.
How long does debt consolidation stay on your credit report?
If you take out a debt consolidation loan, it will stay on your credit report for as long as the loan is open. If you make payments on your loan and keep it in good standing, this can be a good thing. However, if you miss a payment, later payments can stay on your credit report for up to seven years. Your loan application will also result in a hard inquiry, which stays on your credit report for two years, although its impact on your credit will be minimal after one year.
How do I increase my credit score after debt consolidation?
The best way to increase and maintain a good credit score after debt consolidation is to make all your payments on time and keep your debt balances under control. It may be helpful to reflect on what caused you to accumulate debt in the first place so you can try to avoid the same situation in the future.
Add Find the right debt consolidation loan for you today!
If you’re struggling with debt, you’re not alone And you do have option. Look into a debt consolidation loan or one of the options above to start working on financial stability for the future. Call Today!
