How to Consolidate Debt

Juggling several credit card payments each month can be a hassle. Between different due dates, interest rates, and payment amounts, it’s difficult to keep track of where your money is going. Wouldn’t it be great if you could simplify your payments, lower your interest rate, and pay off your debt faster? Luckily, there is. It’s called debt consolidation, and it could be the right answer for you. Read this article to learn more about debt consolidation and find out if you should use this method to pay off your debt.

What is Debt Consolidation?

Debt consolidation is a method of combining multiple debts into a single account, then paying it off under terms that you work out with your new creditor. Most often, you consolidate debt by taking out a loan with a lower interest than you’re paying now. There are many types of loans that can be used for debt consolidation, including unsecured loans like a personal loan or balance transfer card, as well as secured loans like a home cash-out refinance. Debt consolidation could help you simplify your monthly payments, save money on interest, and get out of debt faster. But before you consolidate your debt, you should understand how it works.

How Does Debt Consolidation Work?

The process of debt consolidation involves taking out a new loan or other type of credit to cover your outstanding debts. Once you’re approved, you use the money to pay off your current debts. Then, all you have to do is pay your new creditor under the terms that you have agreed to.

Generally, the length of time you have to pay back these loans ranges from 2-5 years for a personal loan or 5-30 years if you do a cash-out refinance. On the other hand, if you choose to consolidation debt with a balance transfer card, your repayment period is open-ended. Debt consolidation may sound like a great idea, but it isn’t for everyone. So make sure this is the right choice for you before you commit.

Should You Consolidate Your Debt?

When deciding if you should consolidate your debt, there are many factors to consider. Here are some signs that debt consolidation could be right for you.

You have several open accounts

Staying on top of your payments can be tough, especially if you have several open accounts. Debt consolidation could be a good way to reduce the stress on your time and your wallet by simplifying your monthly payment schedule.

You’re paying a high interest rate

If you’re paying high interest rates on your current debts, debt consolidation may be a way to lower your overall interest rate and to pay down your debt faster. You may want to determine the overall average of the interest you are now paying and see if debt consolidation might net you a lower rate.

You have good credit

A high credit score means you’re more likely to get better terms with debt consolidation. If you don’t have good credit, consolidating your debt may not end up saving you money since the interest rate could be higher.

You can afford to pay more than you’re paying now

Debt consolidation could be a faster way to eliminate existing debt. But you should keep in mind that many debt consolidation options will cost you more each month than your current minimum payments. So if you can handle a higher monthly cost, this option may be right for you.

Debt Consolidation Options

Depending on your current financial situation, there may be many debt consolidation options available to you. Knowing the costs and benefits of each is essential to making the right choice.

Debt Consolidation Loans

A debt consolidation loan is a large lump sum of money that you can use to pay off your existing debts. You will then pay back this single loan over time, with a potentially lower interest rate and better terms than what you had previously.

You can seek out a debt consolidation loan from several sources: a bank, a credit union, or an online lender. In all cases, the process will be more or less the same: you will use the money from the loan to pay off existing debts, and then pay back the loan over a pre-determined period of time with regular monthly payments under agreed-upon terms.

Debt consolidation loans are good for those individuals with high credit scores (700 or above), as the interest rate is in part determined by your credit. It also gives you a clear plan and specific end date for paying off your debt, which is good for those who are serious about changing their spending habits and getting rid of debt.

However, if you have a poor credit score, you may have trouble qualifying for a loan with the best rate and terms. And since it’s likely that your personal loan payments could cost more each month than you’re paying right now, this may not be the best option if you’re already struggling to make minimum payments. If you don’t keep up with your loan payments, your debt could become larger—so make sure you can afford to pay back your loan before you take it out.

Pros of Debt Consolidation Loans Cons of Debt Consolidation Loans
Typically have a lower interest rate than credit cards Monthly payments could be greater than what you are obligated to pay now
A specific end date for eliminating debt Must have good credit to qualify for the best terms
A clear plan with regular monthly payments to a single source If you don’t keep up with payments, you could end up in even more debt

Balance Transfer Cards

A balance transfer card allows you to transfer your existing debt from higher-interest cards into a credit card with a low interest rate. You’re essentially using one credit card to pay off another, but if you can get a lower interest rate from your credit card company for the new card, it could end up saving you money.

Often, the introductory rate for a balance transfer card could be as low as 0% during a set period (often six months to a year). If you can pay off all your debt before the end of this introductory period, you may end up paying much less money in total. However, you should be aware that there are typically fees associated with transferring debt onto a balance transfer card.

You’re not likely to receive a balance transfer card unless you have good credit. Also, the amount you can transfer depends on your credit limit with the company, so it works best if you don’t have a very high amount of debt.

Pros of Balance Transfer Cards Cons of Balance Transfer Cards
Typically have a low interest rate Doesn’t eliminate debt, only transfers it
Easy to apply Must have good credit
Many cards have no annual fee Only works for smaller amounts of debt
Many cards have 0% interest intro periods When introductory period ends, rates are the same as other credit cards

Cash-Out Refinance

When you refinance your current mortgage with a cash-out refinance mortgage, you borrow more money than you owe on your current mortgage and use the remaining funds to pay off existing debts. This only works if your home has equity—in other words, if your home is currently worth more than you owe. The equity is transferred into cash, which you can use to help pay off your debts.

If you own a home and have substantial equity in that home, a cash-out refinance may be a good option for paying off existing debt. Your debts can be combined with your mortgage into one convenient monthly payment. Plus, you can extend the amount of time you have to pay off the debt to 5-30 years, depending on the type of loan you refinance to. However, taking out a cash-out refinance may put your house at risk for foreclosure if you are unable to pay back the loan.

Pros of Cash-Out Refinance Cons of Cash-Out Refinance
Interest is typically lower than credit cards You may risk losing your home
More time to pay off the debt Could end up with a higher interest rate than your current mortgage
Tax-deductible interest You’ll have to pay closing costs which can be hundreds or thousands of dollars

You can learn more about cash-out refinancing here.

When Is Debt Consolidation a Bad Idea?

Debt consolidation can be effective for some, but it may not be right for you. Here’s how to tell when debt consolidation is a bad idea.

  • You have more debt than you can afford

If you’re dealing with over $10,000 in debt, debt consolidation may not be the solution to your problem. Consolidating your debt might make you feel like you’ve solved your problem, but you’re essentially transferring your debt to a single account. If you can’t afford to pay off that account, you may find yourself still struggling with debt after consolidation.

  • You’re struggling to make monthly minimum payments

If you’re already having trouble paying the minimum amount due on your debts each month, debt consolidation might not be the answer for you. While a debt consolidation loan could help you get out of debt faster, it could also cost you a lot more each month than you’re paying right now. That’s why it’s important to talk to a loan provider and make sure you can actually afford the loan before you take it out.

  • You have a poor credit score

It’s only worth it to consolidate your debt if you can get a better rate than you’re currently paying on your accounts. However, it can be very hard to get a low-interest debt consolidation loan if you have a poor credit score. If you have poor credit and you are considering debt consolidation, make sure you can get a good rate. Otherwise, you could end up making your financial situation worse rather than better.

Debt Consolidation Alternatives

If debt consolidation isn’t right for you, don’t worry—there are still plenty of options for dealing with your debt. Depending on your financial situation, one of the following alternatives may be right for you.

Debt Management Plan

Debt management companies, also known as consumer credit counseling agencies, are typically non-profit organizations that help people learn how to manage their money better. If you’re struggling with high-interest debt, a credit counseling agency may offer a debt management plan that could help you get out of debt for less by reducing your interest rates.

Here’s how a debt management plan works: you enroll in a plan with a credit counseling agency and pay a small enrollment fee. Then, the credit counseling agency reaches out to your creditors and negotiates a lower interest rate with them. Once your debt management plan is set up and the new interest rates are negotiated, you make monthly payments into an account that your credit counseling agency uses to pay your creditors. They also collect a monthly fee for managing your plan.

Typically, debt management plans could get you out of debt in 36-60 months. This is a good option if the reason you can’t make headway on your debt is your interest rate. However, if you can’t afford to commit to the debt management plan and pay the required amount each month, this option may not be right for you.

Pros of a Debt Management Plan Cons of a Debt Management Plan
You’ll likely pay lower interest than you do currently You have to pay monthly fees to maintain your debt management plan
Your credit score probably won’t be negatively affected Your principal balance (amount before interest) will remain the same
Because a company is working on your behalf, they will do most of the negotiating with your creditors, which means your creditors will be less likely to harass you Could make it difficult to access more credit while you are enrolled in the plan

Learn more about debt management plans here.

Debt Settlement

Debt settlement is a process where you or a company working on your behalf negotiates with your creditors to lower the amount of debt you owe. If you’re able to demonstrate that you can’t pay the full amount you currently owe, debt collectors are often willing to agree to settle your debt for less.

The first step in debt settlement is to voluntarily stop making payments to your creditors and start saving into a separate account that you will use to pay your settlements with your creditors. After you’ve saved up enough money, you or the company you work with will negotiate a settlement with your creditors. Depending on the agreement both sides come to, you could settle your new lowered debt with a large lump sum payment from your saved money, or make payments according to a structured settlement plan.

If you’re struggling with $7,500 or more in credit card, personal loan, or medical debt, debt settlement could help you reduce what you owe and get out of debt in as little as 24-48 months. However, if you’re dealing with more debt than you’ll ever be able to pay off on your own, bankruptcy could be a better option for you.

Pros of Debt Settlement Cons of Debt Settlement
Could significantly reduce your debt Remains on your credit report for up to seven years
Monthly payments may be lower than what you currently pay May negatively impact your credit score
You could be debt-free within two years You may have to pay taxes on settled debt
Lowers the principal balance you owe Some creditors may harass you or even take legal action against you

Learn more about debt settlement here.

Choosing the Right Option

No matter what you decide is the best choice to help you eliminate your debt, you’re doing the right thing by learning about available options. Depending on your particular situation, debt consolidation may be the best option for you—especially if you have a good credit score, can afford to make more than minimum payments each month, or have equity in your home. However, if you’re dealing with a significant amount of debt that you’re struggling to pay on your own, other debt relief options like debt settlement could be right for you.

If you have questions or need help deciding which option is right for you, request a free debt consultation with one of our Certified Debt Consultants today. They’ll walk you through your options and help you figure out the best way to eliminate your debt.