Debt Consolidation
If you need help getting out of debt, you are not alone. Although signs show an upturn in the economy, many Americans are deep in debt, and not everyone can work overtime or a second job to pay down that debt. That’s where debt consolidation and other financial options come in.
What is Debt Consolidation?
Debt consolidation is combining several unsecured debts — credit cards, medical bills, personal loans, payday loans, etc. — into one bill and paying all of them with a single loan. Instead of having to write checks to 5–10 creditors every month, you consolidate bills into one payment, and write one check. This helps eliminate mistakes that result in penalties like incorrect amount or late payments.
There are three major types of debt consolidation: Debt Management Plans, Debt Consolidation Loans and Debt Settlement. These are not quick fixes, but rather long-term financial strategies to help you get out of debt. When done correctly, debt consolidation can:
- Lower your interest rates
- Lower your monthly payments
- Protect your credit score
- Help you get out of debt faster
What Is The Best Way to Consolidate Debt?
There are several ways to consolidate debt, depending on how much you owe. The best way to consolidate credit card debt under $3,000 could be to get a zero-percent interest credit card and transfer balances from high-interest credit cards over to it. You also could look at a personal loan to pay off your balances. You could get a home equity line of credit, a home equity loan or a second mortgage on your home, or refinance your existing mortgage.
Other options include borrowing against a whole life insurance policy and borrowing against you retirement savings. The best way to consolidate a large amount of credit card debt (anything over $3,000) without taking on a new loan, is to enroll in a Debt Management Plan.
Debt Management Plans
Most financial experts agree that a Debt Management Plan (DMP) is the preferred method of debt consolidation. The most-recommended DMPs are run by non-profit organizations. They start with a credit counseling session to help determine how much money you can afford to pay creditors each month. The non-profit agency can help you get a lower interest rate from creditors and reduce or waive late fees to help make your monthly payment affordable. You send one payment to the agency running the DMP and they split it among all your creditors. Utilizing a debt management plan could affect your credit score. However, at the end of the 3-to-5 year process, you should be debt free, which definitely improves your score.
Debt Consolidation Loans
A Debt Consolidation Loan (DCL) allows you to make one payment to one lender in place of multiple payments to multiple creditors. A debt consolidation loan should have a fixed interest rate that is lower than what you were paying, which reduce your monthly payments and make it easier to repay the debts. There are several types of DCLs, including home equity loans, zero-interest balance transfers on credit cards, personal loans, and consolidating student loans. It is a popular way to bundle a variety of bills into one payment that makes it easier to track your finances. There are some drawbacks — you could face a longer repayment period before you finish paying off the debt — but it’s definitely worth investigating.
What Is Bill Consolidation?
Bill consolidation is an option to eliminate debt by combining all your bills and paying them off with one loan. With bill consolidation, you make only one monthly payment — a good idea for when you have five, or maybe even 10 separate payments for credit cards, utilities, phone service, etc. If you consolidate all bills into one, the single payment should be at a lower interest rate and reduced monthly payment. Any savings could be used to start an emergency fund to help prevent a future financial crisis.
How to Get a Consolidation Loan
Banks and credit unions are good places to ask about consolidation loans, but online lending sites may be a better place to borrow. The key is to know how to consolidate your bills. Start by listing each of the debts you intend to consolidate — credit card, phone, medical bills, utilities, etc. — and what the monthly payment and interest rates are on those bills. It also helps to know your credit score.
Once you have this information, make sure to compare lender’s rates, fees and length of time making payments before making a decision. A consolidation loan should reduce your interest rate, lower your monthly payment, and give you a practical way to eliminate debt.
How to Consolidate Credit Card Debt on Your Own
If you have a very good credit score (700 or above), the best way to consolidate credit card debt is to apply for a 0% interest balance transfer credit card. The 0% interest is an introductory rate that usually lasts for 6–18 months. All payments made during that time will go toward reducing your balance. When the introductory rate ends, interest rates jump to 13–27% on the remaining balance. Be aware, however, that balance transfer cards often charge a transfer fee (usually 3%), and some even have annual fees.
Another DIY way to consolidate your credit card debt would be to stop using all your cards and pay using cash instead. This can allow you to set aside a portion of your income each month to pay down balances for each card, one at a time. When you have paid off all the cards, choose one and be responsible with how you use it.
How Can I Consolidate My Bills?
Debt and bill consolidation takes patience, persistence and some organizational skills. You must start by gathering all your bills for things like medical, credit card, utilities, cell phones. Add the total amount owed on the unsecured debt. The next step is to determine how much you can afford to pay on a monthly basis, while still having enough to pay basics such as rent, food and transportation.
When you have that number, decide whether a personal loan, debt management program or debt settlement gives you the best chance to eliminate the debt. Understand that this process normally takes between three to five years. There are no easy fixes with debt consolidation.
When Not To Consider Debt Consolidation
Debt consolidation is an appealing way to simplify your bill paying process, but depending on the method you choose – balance transfer on credit cards; debt settlement; secured personal loan – there are reasons it may not be the appropriate choice for all consumers.
If, for example, you choose to pay off credit card debt with a zero-interest balance transfer to a new card, but you continue to use the new card the same way you did your old cards, you create even more debt.
If you decide to use debt settlement, your credit score will take a severe hit that will last seven years, which will make it difficult to get a loan for a car or home in that time. Also, there will be a significant spike on interest rates for any credit cards you obtain. However, using a secured loan to consolidate bills might be the riskiest choice. If you put a home or car up as security, you may get a better interest rate, but any missed payments put you in danger of losing that car or home.
For debt consolidation to work, you must calculate how many payments it will take and how much interest is included in those payments for you to eliminate the debt and see if the time and money involved is less than doing it your current way. It will be difficult. If you are not really committed to changing the habits that got you into financial trouble, the cost and time for debt consolidation may make the situation worse.
Debt Consolidation vs. Debt Settlement
These two repayment methods are often confused with each other, but they are vastly different.
Debt settlement companies promise to negotiate a lump-sum payment with each one of your creditors for less than what you actually owe. While this sounds ideal, there are drawbacks. Many creditors refuse to deal with debt settlement companies and debt settlements have a huge negative impact on your credit score.
Debt consolidation means taking out a single loan to pay off several unsecured debts. You make one payment to the lender each month, instead of multiple payments to multiple lenders. Debt consolidation has a positive impact on your credit score as long as you don’t miss any payments.
Debt settlement companies, on the other hand, ask clients to stop paying creditors and instead send a monthly check to the settlement company that is deposited in an escrow account. When the account reaches a specific dollar goal — this sometimes takes as long as 36 months – the settlement company steps in and makes its offer to the creditor. The creditors are not bound to accept the offer. Late fees and interest payments also accumulate during this time, making the amount owed much larger.
If you choose to use a debt settlement company, you should not pay any fees until the debt has been settled. Be sure they put in writing how much you pay in fees and how long the process will take. Remember that creditors can refuse to deal with settlement companies.
If you choose a debt consolidation company, be sure to get their fees and interest charges in writing.
Debt Consolidation Stories & Examples:
Talk to a Credit Counselor
Sometimes solutions to overwhelming financial problems are only one phone call and a credit counseling session away.
Sheri Long — who has only 16 months left on her Debt Management Program that eliminated $13,000 worth of credit card debt — will vouch for that.
Two years ago, an angry knock on the front door by her landlord put a scared look on her two daughters faces and signaled to Sheri that things were about to hit rock bottom. The rent was past due. The utility bill and doctor’s bill for her youngest daughter’s last visit came in the mail the day before.
Sheri had a paycheck coming that Friday, but it wasn’t going to cover all her debts. Her four credit cards were maxed out. This was the end of an economic spiral that started three years earlier when she got divorced and then laid off within six months of each other.
Sheri went from making $48,000 a year at a huge retail store as a supplement her husband’s income to making $34,000 at a small local shop and receiving sporadic child support checks from her ex-husband.
Meanwhile, the bills kept coming. And coming. And coming.
She used credit cards to pay nearly every bill. When one card maxed out, she switched to another or signed up for “zero-percent interest” balance transfers. When the zero-percent financing expired, interest rates between 17 and 25% replaced them.
Sheri couldn’t keep up. Total charges on her card climbed over $13,000. All she could do was make minimum payments on some cards, while trying to pay down the others. And now, the landlord was knocking.
For months, a concerned friend had suggested she call a credit counseling agency and she finally did.
The credit counselor asked about her income and expenses and told her she qualified for reduced interest rates on the credit cards. The counselor also worked with companies to reduce the late fees and talked to Sheri about cutting down on trips to restaurants, shopping and family vacations.
That started the ball rolling toward recovery. The credit counselor helped Sheri devise a budget that was tight, but doable. As long as Sheri made her monthly payments, she would eliminate the debt in five years.
It’s Year 3 and Sheri already can see the finish line. She has taught the girls to cook and now all meals are made at home. She pays cash for nearly everything, which means buying a new dress or the latest electronic toy becomes a painful decision. She still has one credit card “for emergency use only” and she’s stuck to that for more than two years now.
Sheri receives monthly updates from the credit counseling agency. The latest one says she has paid off more than 60% of her debt, already. The updates encourage her so if she comes up with any unexpected income – the ex-husband has become more regular with child payments – she immediately applies it to her debt.
Her job is stable and the economy shows encouraging signs for growth in the future. Her original 5-year plan to eliminate debt will take just under four years. Best of all, no one is knocking on the door asking to get paid.
And her daughters wake up with the smiles you expect from growing children.
Is Debt Consolidation Right for Me?
A. If you are overwhelmed with unsecured debt (e.g. credit card bills, personal loans, accounts in collection), and can’t keep up with the high interest rates and payment penalties that normally accompany those obligations, debt consolidation is a viable debt relief option. It allows you to focus on making one monthly payment, ideally at a lower interest rate. However, you need to be highly-motivated to eliminate debt and disciplined enough to stay on a program that could take 3–5 years before you are debt-free.
Which Debt Consolidation Plan Is Right for Me?
A. There are so many choices available that it is impossible to single out one. The Federal Trade Commission recommends contacting a non-profit credit counseling agency to determine which debt consolidation plan best suits your needs. The credit counselors educate consumers about debt and offer options to eliminate it. Credit counselors are available for over-the-phone or in-person interviews, and their service is usually free.
Can I Consolidate My Debt Without a Loan?
A. 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 and works with creditors to lower interest rates and possibly eliminate some fees. The two sides agree on a payment plan that fits your budget. This is not a quick fix. DMPs normally take 3-5 years, but by the end, you eliminate debt without taking on another loan.
Do Lenders Perceive Debt Consolidation Negatively?
A. 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.
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