Debt consolidation is a sensible solution for consumers overwhelmed by credit card debt. It can be done with or without a loan. Consolidation cuts costs by lowering the interest rate on debts and reducing monthly payments.
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What is Debt Consolidation?
Debt consolidation is a financial strategy, merging multiple bills into a single debt that is paid off by a loan or through a management program.
Debt consolidation is especially effective on high-interest debt such as credit cards. It should reduce your monthly payment by lowering the interest rate on your bills, making it easier to pay off the debt.
This debt-relief option untangles the mess consumers face every month trying to keep up with multiple bills from multiple card companies and multiple deadlines. Instead, there is one payment to one source, once a month.
And it saves you money at the same time!
There are two major forms of debt consolidation – taking out a loan or signing up for a debt management program that doesn’t include a loan. It’s up to consumers to decide which one best suits their situation.
Debt consolidation is also referred to as “bill consolidation” or “credit consolidation.” By any name, consolidating debt effectively should get you out of debt faster and eventually improve your credit score.
How Does Debt Consolidation Work?
Debt consolidation works when it lowers the interest rate and reduces the monthly payment to an affordable rate on unsecured debt such as credit cards.
The first step toward making debt consolidation work is calculating the total amount you pay for credit cards every month and the average interest paid on those cards. That provides a baseline number for comparison purposes.
Next, look at your monthly budget and add up spending on the basic necessities like food, housing, utilities and transportation.
How much money is left? That is the critical question.
For many people, there is enough left to handle their debt if they organize their budget better and get motivated to pay down debt. However, those characteristics – effective budgeting and motivation – aren’t generally evident when people fall behind on their bills.
And that’s is where a debt consolidation loan or debt management program can step in. Each requires one monthly payment (organization) and allows you to track your progress as you eliminate the debt (motivation).
Doing some research and calculations will tell you whether a loan or debt management program will help more in paying off the debt.
Debt Consolidation with a Loan
The conventional method for consolidating debt is to get a loan from a bank, credit union or online lender. The loan should be large enough to eliminate all the unsecured debt at one time.
The loan is repaid in monthly installments at an interest rate you negotiate with the lender. The repayment period is normally 3-5 years, but how much you interest you are charged is the key element.
Lenders look closely at your credit score when determining the interest rate they charge for a debt consolidation loan. If you are falling behind paying off your credit card debt, it’s very likely your credit score is tumbling, too.
If the interest rate you get for a debt consolidation is not lower than the average interest rate you already were paying on your credit cards (see above), then a debt consolidation loan does you no good.
There are alternative loan possibilities such as home equity loans or personal loans, but neither helps if you can’t improve the interest rate you’re paying or the repayment period is so long it doesn’t make sense.Learn More About Debt Consolidation Loans
Debt Consolidation without a Loan
It is possible to consolidate your debt and reduce your monthly payments without taking out another loan.
Nonprofit credit counseling agencies offer debt consolidation through a debt management program, which doesn’t require the consumer to take out a loan.
Instead, the nonprofit credit counseling agencies work with card companies to reduce the interest rate and lower the monthly payment to an affordable level for the consumer.
...if you’re ready to turn your financial life around, debt consolidation can help do it.
The consumer sends a monthly payment to the credit counseling agency, which then distributes the money to each creditor in an agreed upon amount. The agency may also get the card companies to waive late fees or over-the-limit fees.
This is not a quick solution. Debt management programs usually take 3-5 years to eliminate debt. If you miss a payment, they can revoke whatever concessions were made on your interest rate and monthly payment.
Should I Consolidate My Debt?
If you are tired of seeing your credit card balance rise every month … and the balance has reached levels that are starting to overwhelm you ... and you are weary of the anxiety this is bringing into your life every month … and you just need a plan you can follow … then yes, debt consolidation is something you should strongly consider.
In other words, if you’re ready to turn your financial life around, debt consolidation can help do it.
Nearly everyone losing the battle with debt has this conversation with themselves every month. You want to be responsible with your money and you want to step away from credit card dependence, you just need a plan.
Debt consolidation is a plan. It simplifies bill paying. It gives you a reachable goal to meet every month and eventually lets you breathe again financially. You will have to do some research and comparison, but the essence of debt consolidation can be summed up like this:
- One affordable payment, once a month, to one source
If you can put that on your plate, yes, debt consolidation will work for you.
When Is Debt Consolidation Not a Good Option?
If you don’t plan to change your spending habits – i.e. you still plan to use your credit card for anything you want – then debt consolidation is not for you. The chase to catch up with your bills will never end.
Putting the credit card away would be a first step, but not the only one you need to consider before deciding that debt consolidation is your financial savior. Here are some other questions you need to answer:
- Are you willing to make a serious monthly budget and stick to it?
- Does taking out a new loan to pay off old loans (credit card debt) make sense?
- Are you willing to calculate whether the fees and costs associated with a debt consolidation loan – not to mention the length of the repayment period – will end up saving or costing you more money than your current payment arrangement?
- Do you understand that a debt management program requires a constant, on-time monthly payment in order to retain the privileges of the program?
If you can’t answer yes to all the questions, then debt consolidation might just be another road in the wrong direction for you.
Alternatives to Debt Consolidation
The decision to reduce debt is very much like the decision to reduce weight: the sooner you get started, the easier it’s going to be.
Debt consolidation is an early stage treatment. However, if your debt has reached the obese stage – not just overwhelming, but embarrassing – you might need to look at debt settlement or bankruptcy as your way out.
Pros for bankruptcy:
- You get a second chance, a “fresh start” financially.
- Chapter 7 bankruptcy only takes 3-6 months and all debts are forgiven
- Won’t lose exempted items like retirement savings and could keep house, car, and work-related possessions.
Cons against bankruptcy:
- You will lose access to credit cards
- Chapter 7 remains on your credit report 10 years. Chapter 13 is there seven years.
- Most possessions are sold to pay off creditors.
Pros for debt settlement:
- Reduces amount of debt you pay, possibly by as much as 50%
- May help avoid lawsuits or court judgments
Cons for debt settlement:
- Balance due will grow because of interest rate and late payment penalties
- Not all companies accept debt settlements
- Damages your credit score for seven years
- IRS taxes are owed on amount forgiven
Debt Consolidation FAQs
Is debt consolidation bad?
It can be if you don’t change the habits that caused your debt. If you continue to overspend with credit cards or take out more loans you can’t afford, rolling them into a debt consolidation loan will not help.
How do I consolidate debt and pay it off?
The first step is to list the amount owed on your monthly unsecured bills. Add the bills and determine how much you can afford to pay each month on them. Your goal should be to eliminate debt in a 3-to-5 year window. Reach out to a lender and ask what their payment terms – interest rate, monthly payment and number of years to pay it off – would be for a debt consolidation loan. Compare the two costs and make a choice you are comfortable with.
What type of loans can I consolidate?
Any unsecured debt, which includes credit cards, medical bills or student loans.
What are the best loans for debt consolidation?
Depending on the amount owed, the best consolidation loans are credit card balance transfers, personal loans, home equity loans and an unsecured debt consolidation loan. A good-to-excellent credit score is needed for credit card balance transfers. Peer-to-peer online lending has become a good outlet for personal loans. A home equity loan is a secured loan, which means better interest rates, but you are in danger of losing your home if you miss payments. An unsecured debt consolidation loan means not risking assets, but you will pay a higher interest rate and possibly receive a shorter repayment period.
Who qualifies for debt consolidation loans?
Anyone with a good credit score could qualify for a debt consolidation loan. If you do not have a good credit score, the interest rate charged and fees associated with the loan, could make it cost more than paying off the debt on your own.
Can I consolidate my debt without a loan?
Yes. A debt management program (DMP) is designed to eliminate debt without the consumer taking on a loan. A credit counseling agency takes a look at your monthly income to help you build an affordable budget. Counselors work with creditors to lower interest rates and possibly eliminate some fees. The two sides agree on a payment plan that fits your budget. DMPs normally take 3-5 years, but by the end, you eliminate debt without taking on another loan.
How does debt consolidation affect your credit?
Generally speaking, debt consolidation has a positive impact on your credit score as long as you make consistent on-time payments. The two major factors involved in determining its effect on your credit score are a) which debt consolidation program you use; and b) how committed are you to making on-time payments?
If you choose a debt management program, for example, your credit score will go down for a short period of time because you are asked to stop using credit cards. However, if you make on-time payments in a DMP, your score will recover, and probably improve, in six months.
If you choose a debt consolidation loan, your poor payment history already has dinged your credit score, but paying off all those debts with a new loan, should improve your score almost immediately. Again, making on-time payments on the loan will continue to improve your score over time.
Debt settlement is a no-win choice from the credit score standpoint. You score will suffer immediately because debt settlement companies want you to send payments to them and not to your creditors. That's a big problem. So is the fact that a debt settlement stays on your credit report as a negative consequence for seven years.
Are debt consolidation loans taxable?
The IRS does not tax a debt consolidation loan. More importantly, it does not allow you to deduct interest on a debt consolidation loan unless you put up collateral, such as a house or car.
How much does it cost to consolidate your debt?
The cost of debt consolidation depends on which method you choose, but each one of them includes either a one-time or monthly fee. You will pay interest on a debt consolidation loans and taxes on debt settlement. Generally speaking, the fees are not overwhelming, but should be considered as part of the overall cost of consolidating debt.
Which debt consolidation plan is right for me?
There are so many choices available that it is impossible to single out one. The Federal Trade Commission recommends contacting a nonprofit credit counseling agency to determine which debt consolidation plan best suits your needs. You may ask yourself, what does a credit counselor do? Credit counselors help consumers set up a budget and offer options to eliminate debt. Credit counselors are typically available for over-the-phone or in-person interviews, and their service is usually free..
Does debt consolidation work on a limited income?
Debt consolidation loans are difficult for people on a limited income. You will need a good credit score and sufficient monthly income to convince a lender that you can afford payments on the loan. A better choice might be to consult a nonprofit credit counselor and see if you are better served with a debt management program.
Do lenders perceive debt consolidation negatively?
Most lenders see debt consolidation as a way to pay off obligations. The alternative is bankruptcy, in which case the unsecured debts go unpaid and the secured debts (home or auto) have to be foreclosed or repossessed. Lenders don’t like either of those choices. You may see some negative impact early in a debt consolidation program, but if you make steady, on-time payments, your credit history, credit score and appeal to lenders will all increase over time.
What is debt consolidation refinancing?
It means including other debts in a refinancing of your home. If you have $10,000 in credit card debt and owe $90,000 on your home, you would refinance the home for $100,000 and use $10,000 of that money to do a one-time payoff of your credit card debt. This is only a valuable if you have equity in your home (market value is higher than mortgage balance) and you receive a lower interest rate and monthly payment on your new mortgage.
Who can help me consolidate my debt?
Be careful. Debt consolidation companies are not all the same. Look for a company with good reviews, a high grade with the Better Business Bureau and that is transparent about services and fees.
Can I consolidate medical debt?
Yes, you can consolidate medical debt. However, there may be little benefit in doing so, as medical debt is typically low to no interest debt. Medical debt consolidation may provide no savings based on a lower interest rate.
How do I consolidate my student loans?
If you’re having difficulty making payments, you may want to consider consolidating your student loans under one of the many available repayment programs available on Federal student loans. Interest rates will be the same, but you can lower your monthly payment by electing a longer term or choosing an income-based repayment program.
Do It Yourself Credit Card Consolidation?
The Do It Yourself (DIY) method of consolidating credit card debt is time consuming and fraught with frustration, but it can be done. Call the card companies and try to negotiate lower rates and maybe even a break on your balance. Be aggressive, but be aware that the success rate is low.
The alternative DIY method is obvious: Get rid of your credit cards. Lock ‘em in a drawer and hide the key. Pay for everything in cash. Set aside a portion of your income every month to pay down balances one card at a time, until they are all paid off.
Need help choosing the best debt relief option for you?Get Debt Consolidation Help Today
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