Debt Consolidation

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.

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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.

Box of coins with debt consolidation loans written on a sign

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.

Writing debt consolidation in a notebook

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.

Bankruptcy


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.
Learn More About Bankruptcy

Debt Settlement


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
Learn More About Debt Settlement

Debt Consolidation FAQs

Is debt consolidation bad?

How do I consolidate debt and pay it off?

What type of loans can I consolidate?

What are the best loans for debt consolidation?

Who qualifies for debt consolidation loans?

Can I consolidate my debt without a loan?

How does debt consolidation affect your credit?

Are debt consolidation loans taxable?

How much does it cost to consolidate your debt?

Which debt consolidation plan is right for me?

Does debt consolidation work on a limited income?

Do lenders perceive debt consolidation negatively?

What is debt consolidation refinancing?

Who can help me consolidate my debt?

Can I consolidate medical debt?

How do I consolidate my student loans?

Do It Yourself Credit Card Consolidation?

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Author

Staff Writer

Bill Fay is a journalism veteran with a nearly four-decade career in reporting and writing for daily newspapers, magazines and public officials. His focus at Debt.org is on frugal living, veterans' finances, retirement and tax advice. Bill can be reached at bfay@debt.org.

Sources

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