How to Consolidate Debt On Your Own
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Everyone knows the term “drowning in debt.” It suggests a person who has lost control of their finances and is about to go under without the help of a debt counselor or loan management firm. But seeking outside help isn’t the only solution. Sometimes people save themselves (and money!) through Do-It-Yourself (DIY) debt consolidation.
The DIY method isn’t for everyone, but if you have the discipline to create a plan, sell your creditors on the plan’s merits and follow through with the required payments, it can be done.
Debt consolidation offers several pluses. It simplifies repayment, turning a mashup of credit card balances into a single payment, often at a lower interest rate and monthly payment. If you devise your own plan instead of turning to a bank or company that specializes in debt consolidation, you can save administrative and other fees. It also can speed up the amount of time it takes to get out of debt. That’s especially true if you convince creditors to take a smaller “lump sum payment” that is less than what you owe. That requires negotiation, and some creditors might not be willing to talk to you, but if they do – and you pay off the debt for less than what is owed – that could be considered a win.
However, if you go it alone, you need to craft a plan you can afford that doesn’t leave you in greater financial jeopardy than you were in when you started. It’s important to consider the ramifications of your decision, especially if you use collateral like your home equity as part of the plan.
Consolidating a mish-mash of credit card balances to a single, zero-interest credit card is an easy way to streamline your payments and pay less interest. However, it comes with an imposing qualifier: You must have a good credit score – 690 or better is recommended – and that usually is a problem if you’re behind on payments.
If you do have a good score, you probably receive offers from card issuers enticing you to transfer your balances to their cards, often with a no-interest grace period of 12-18 months or more and no transfer charges.
Balance transfers with suspended interest payments can supercharge efforts to pay down debt. Of course, you need to read the fine print carefully so you know when the grace period ends and what the interest rate on the remaining balance will be. In April of 2019, you could count on the interest rate being somewhere in the 15%-25% range.
The key is doing the math. There is no point transferring balances to a single card if doesn’t save you money. Even if you decide it makes sense, you need to have a card with a large enough credit line to handle you assorted debts. If you do, or you can convince a card issuer to increase your credit line, it might be a good way make your debts more manageable.
Home Equity Loan or Line of Credit
Home equity loans and their variant, home equity lines of credit (HELOCs), are what used to be called second mortgages. These loans allow you to borrow against home equity – the difference between how much your home is worth and how much you still owe – usually at rates far lower than you’re paying on credit card debt.
The downside – your house secures the loan and you could lose it – is the reason why you get a lower rate on an equity loan than consumer debt. If you are comfortable with that, equity loans allow you to make regular, predictable payments. If you have sufficient equity in your home and you meet other income and credit standards, you can take a loan or get a credit line that will allow you to transfer all your credit card debt to a home loan that you then can repay in regular installments.
The downside is the collateral. If for some reason you can’t afford the payments in the future – perhaps because of an illness or job loss – you could lose your home through foreclosure. Financial advisers often warn clients not to convert the unsecured debt on credit cards to a secured debt on your home for that reason.
The same holds true for another home loan option, cash out refinancing. In this case, you refinance your primary mortgage, turning it into a larger loan with hopefully a lower interest payment. You can then use the cash you take out of the refinancing to pay off your credit card debts.
Again, the strategy turns unsecured debt into secured debt, a risky maneuver.
Debt Consolidation Loan
Lenders, including banks and credit unions, offer loans designed to replace an assortment of consumer debt with a single loan, usually at a lower interest rate. Though debt consolidation loans work for some, it’s important to understand the lenders’ terms and the potential risks if you miss payments.
Banks and credit unions are the best source of unsecured loans, but they tend to be selective about who they approve. People with the best credit scores get the lowest interest rates. If you have several credit cards with balances that carry 25% annual interest rates and your bank offers a loan to pay off that debt with a consolidation loan carrying an 8% rate, taking the loan could work well. Credit unions tend to offer better deals than banks, so shop around.
Online lenders are another option. These lenders often approve a loan in a few days and will accept borrowers with lower credit scores than banks or credit unions. Of course, the interest rates will be higher.
The worst option, one you should probably avoid, are storefront lenders and debt consolidation companies that add extra fees for originating loans and charge much higher interest rates. Avoid for-profit companies and always carefully review the terms.
Before taking a debt consolidation loan, understand about the repayment period, whether the interest rate during repayment is fixed or variable and if you can afford the monthly payments. Also, avoid loans that demand collateral. The debt consolidation loan business has a spotty reputation and there are many scam artists. You need to be diligent and avoid hucksters.
Borrow from Retirement
Borrowing from an employer-sponsored retirement plan such as a 401(k) loan gives you access to money that can be used to pay your debts. Before considering this alternative, you need to understand restrictions that apply to retirement-account borrowing.
- You have five years to fully replay a 401(k) loan or face early-withdrawal and tax penalties.
- If you leave your job for any reason, you have to repay the loan balance within 60 days or pay early-withdrawal penalties.
- You can’t borrow more than 50% of the vested value of your 401(k), and your loan can’t exceed $50,000.
- If your 401(k) vested balance is $10,000 or less, you can borrow the full amount. Your employer can charge a reasonable interest rate on the loan, and repayments of principal and interest musts be made at least quarterly.
One advantage to a retirement account loan is that you are borrowing from yourself, which means the debt isn’t part of your credit report and won’t appear on your credit report.
Remember that this is your retirement money. If you fail to repay it, you will lose the money. Even if you do repay the loan, you will lose whatever growth the amount you borrowed might have accrued if the money remained in your account.
Work with a Nonprofit Credit Counseling Agency
Nonprofit debt counselors can review the options you might consider for consolidating your credit card and other debt and will likely propose a plan for consolidating the debt into a single payment.
The plan might involve negotiating a lower balance with your creditors and consolidating the debt into a single, lower-interest payment called nonprofit debt consolidation. It likely will limit the money you can spend on other things during the repayment period. You can speak to a credit counselor for advice on a do-it-yourself plan or with help working with creditors and creating a managed plan.
Before picking a debt consolidator, do some research. Though some call themselves nonprofit organizations, they may actually make a good deal of money at the expense of their clients. You should ask questions about the cost of building a plan, and whether the company charges minimum setup and monthly charges.
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- Aldrich, E. (2019, March 24) How to Get a Debt Consolidation Loan with Bad Credit. Retrieved from: https://www.bankrate.com/loans/debt-consolidation-loans-with-bad-credit/
- Page, A. (2017, December 14) 5 Easy DYI Ways to Consolidate Your Debt. Retrieved from: https://www.fundandgrow.com/blog/diy-ways-to-consolidate-debt
- Pinyo (2013, January 13) How to Do Your Own Debt Consolidation and Get Out of Debt. Retrieved from: http://www.moolanomy.com/1137/do-it-yourself-debt-consolidation/
- NA, ND. Do It Yourself Debt Consolidation. Retrieved from: https://www.myfinancialgoals.org/education/do-it-yourself-debt-consolidation.htm