Debt consolidation can be an effective way for borrowers to simplify their finances by combining multiple debts into one single payment. This comprehensive guide covers the ins and outs of debt consolidation, including the pros and cons, different strategies, and tips for success. Read on for everything beginners need to know to make an informed decision about debt consolidation.
What is Debt Consolidation?
Debt consolidation involves taking out a new loan to pay off multiple existing debts. This allows the borrower to combine all their debt payments into one lower monthly payment.
There are a few main types of debt consolidation loans:
- Personal loans – An unsecured personal loan from a bank, credit union or online lender used to pay off credit card or other high-interest debt. These typically have fixed interest rates and terms of 2-5 years.
- Balance transfer credit cards – Transferring multiple credit card balances onto a new card with a 0% intro APR period allowing you to pay down balances interest-free for a set period (usually 12-21 months).
- Home equity loans/lines of credit – Secured loans using available equity in your home as collateral. These typically have lower interest rates but put your home at risk if you default.
- Debt management plans (DMP) – Provided by credit counseling agencies, these can negotiate lower interest rates and facilitate monthly payments to creditors.
The key benefit of debt consolidation is simplifying multiple payments into one, ideally at a lower interest rate, making payments and finances easier to manage. It can also allow you to pay off debt faster.
Pros and Cons of Debt Consolidation
| Pros | Cons |
|---|---|
| Lower monthly payment | Closing credit accounts can temporarily hurt your credit score |
| Single payment vs multiple | Consolidation fees and penalties |
| Lower interest rate possible | Loans may have origination fees |
| Fixed payoff period | Risk losing collateral with secured loans |
| Helps pay off debt faster | Doesn’t address overspending issues |
| More organized finances | Potential prepayment penalties |
Debt Consolidation Strategies for Beginners
1. Evaluate if You Qualify for a Balance Transfer Card
Balance transfer credit cards allow you to consolidate debt at a 0% intro APR for an initial period, typically 12-21 months. This pause on interest accumulation can help you aggressively pay down principal debt.
To qualify, you’ll need good to excellent credit (690+ FICO score). Check your credit reports to ensure your score qualifies and that you don’t have late payments, which can disqualify you. Limit balance transfers to credit card debt only, not other loans.
Cards like Chase Slate or Citi Simplicity offer 0% intro periods and no balance transfer fee. Compare cards to pick the best terms for your situation. Make a payoff plan to pay balances before the 0% rate expires.
2. Consider Taking Out a Personal Loan
Unsecured personal loans allow you to consolidate and pay off credit card balances and other debts at fixed interest rates often lower than credit cards. Rates range from 5-36% based on credit, with excellent credit needed for the lowest rates.
Banks, credit unions and online lenders like Lightstream and SoFi offer personal loans with fixed monthly payments and terms from 2-7 years typically. This can help you pay off debt faster by locking in a set repayment schedule.
Look for lenders offering prequalification to check potential rates without a hard credit inquiry. Compare loan offers from multiple lenders. Online marketplace Credible lets you easily compare personal loan rates.
3. Research Nonprofit Credit Counseling Programs
Nonprofit credit counseling organizations like NFCC offer free consultations to review your budget and provide advice on managing debt. They can set up debt management plans (DMP) to work with creditors to lower interest rates and consolidate monthly payments.
DMPs charge small monthly fees, have little to no effect on credit, and get results through creditor negotiation rather than new loans. Creditors may waive fees, reduce rates to 0-5%, or freeze interest to help get debts paid.
Ask about program details as offerings vary. Some require closing accounts or stopping payments which can impact credit negatively. Compare multiple agencies.
4. Evaluate Home Equity Loans or HELOCs
Homeowners with sufficient equity can utilize home equity loans (HEL) or lines of credit (HELOC) at lower interest rates to consolidate debt. However, these put your home at risk as collateral if you default.
HELOCs have variable rates while HELs have fixed rates. Compare options from lenders like banks, credit unions and online lenders. Terms are often 10-30 years for HELs and 10-20 for HELOCs. Closing costs typically range 2-5% of the loan amount.
Only pursue this option if you can get a substantially lower rate to make it worthwhile. A financial advisor can help analyze if it’s your best debt consolidation choice.
5. Communicate with Creditors for Better Terms
Contact creditors directly to request better repayment terms before considering major consolidation. Explain financial hardship and ask them to waive fees, reduce or freeze interest rates, or create a payment plan.
This option requires a good payment history and works best for resolving short-term issues. It offers flexibility but requires negotiation skills and discipline to stick to new payment plans. Get any agreements in writing.
Hardship programs for federal student loans or mortgage forbearance are other examples of direct creditor negotiation to make debts more affordable.
6. Use DIY Debt Payoff Methods
For motivated borrowers disciplined enough to stick to a regimen, do-it-yourself debt payment plans let you consolidate and pay off debt without loans. Popular strategies include:
- Debt snowball: Pay minimums on all debts except the smallest which you aggressively pay off first before moving to the next smallest. This gives motivation through small wins.
- Debt avalanche: Pay minimums on all debts except the one with the highest interest rate which you focus payment on first for the best math.
- 50/30/20 budget: Allocate 50% of after-tax income to necessities, 30% to lifestyle costs, and 20% to debt payments. The higher percentage focused on debt repayment accelerates payoff plans.
- Balance transfer card: Move balances to a 0% card for a set period to pay down balances faster when interest pauses. Do this in combination with a payoff strategy.
These DIY methods require very disciplined budgeting and additional payments but let you become debt-free sooner without consolidation loans.
Tips for Successfully Consolidating Debt
- Maintain minimum payments on all debts until the consolidation loan is disbursed and use loan funds to pay off debts instead of receiving disbursements directly.
- Be cautious of balance transfer offers with high fees or short intro 0% periods that don’t save money in the long run.
- Avoid tapping consolidated credit cards or closing accounts which can negatively affect credit utilization and scores.
- Pick the debt repayment strategy most motivating for your habits and commit to consistency. Consider debt counseling if lack of discipline is an issue.
- Consolidate only when beneficial – if interest savings exceed fees incurred. Otherwise focus on repaying debts individually.
- Pay more than the minimum whenever possible on installment consolidation loans to pay off fast and save on interest.
- Contact creditors immediately if you anticipate issues making payments to discuss hardship options. Don’t wait until after missing payments.
Debt Consolidation FAQs
Does debt consolidation hurt your credit?
It can temporarily hurt your credit score but won’t harm your credit history if payments are made on time. Closed accounts lower total available credit which raises credit utilization ratios. Hard inquiries for loans also ding scores temporarily.
How long does debt consolidation stay on your credit report?
Debt consolidation loans can remain on your credit report for 7-10 years depending on the credit bureau. If accounts were in good standing at payoff, they can contribute positively to credit history aging over this period.
Can you consolidate federal student loans?
Federal student loans can be consolidated through the government’s Direct Consolidation Loan program to combine multiple federal loans into one new loan with a fixed interest rate and term of up to 30 years. This can simplify repayment but won’t necessarily save money on interest.
What is the difference between debt settlement and debt consolidation?
Debt settlement involves negotiating with creditors to settle accounts for less than the full balance owed. This requires stopping payments and often ruins credit. Debt consolidation combines debts into one new loan to simplify and repay the full balances owed.
Is debt consolidation a good idea for bad credit?
It can be if it helps qualify you for a lower interest rate loan that enables you to save money while repaying debt. Debt management plans through credit counseling agencies are also an alternative if you can’t qualify for typical consolidation loans.
The Bottom Line
Debt consolidation can be a helpful tool for simplifying payments and paying off debt faster by consolidating multiple debts into one monthly payment. Weigh the pros and cons for your unique situation and compare all options – from balance transfer cards to personal loans to DIY payoff plans – to choose the best debt consolidation strategy for your needs. Maintain financial discipline throughout the process to achieve a debt free future.