If your growing credit card and student loan debts worry you, you’re in good company. Many American consumers are drowning in debt. In fact, one in five Americans now carry more credit card debt than they have in savings. High debt loads often limit consumers’ ability to save for retirement, or even to pay their monthly bills. As a result, more and more people view getting out of debt as a top priority.
Borrowers deal with excessive debt in many different ways. An increasingly common way to address high level of personal debt is through debt consolidation, typically through some sort of loan. There are several different types of debt consolidation, each with its own advantages and disadvantages. Let’s look at the three most commonly used forms of debt consolidation.
First, we should discuss exactly what debt consolidation is.
What’s debt consolidation, anyway?
When using debt consolidation, borrowers combine all their outstanding debts into a single new loan. After doing so, the borrower will have only one interest rate and monthly payment to contend with. Typically, a debt consolidation loan is issued at a lower interest rate and longer payment timeline than the borrower’s original debts; this makes the new monthly payment easier for the borrower to manage, especially in relation to other outstanding bills.
Debt consolidation is a proven way for tapped-out borrowers to get out from under a crushing load of debt. The single, lower payment often allows borrowers to assume greater control of their finances, and ultimately start paying down their debts. However, this form of debt repayment does have some disadvantages. It’ll normally take borrowers longer to pay off their debts with a debt consolidation loan, since it’s issued with a longer payment timeline, for example. Borrowers who choose this option to pay off debts will likely stay in debt longer than if they had chosen other methods to deal with outstanding credit card balances.
Now that we’ve reviewed what debt consolidation is, let’s look at some of the most common means available for borrowers to consolidate their debts.
One of the most widely used forms of debt consolidation is an unsecured loan. An unsecured loan is simply a loan that a bank or other lender issues explicitly for borrowers to consolidate their existing debts. These types of loans have several benefits. Borrowers who obtain one will have a fixed rate of interest that won’t change throughout the life of the loan. However, borrowers who are stressed financially due to outstanding debt may find it difficult to qualify for an unsecured loan; additionally, borrowers who can qualify for one may not be eligible for interest rates that are advantageous, either.
A second way to achieve debt consolidation is to take advantage of the many credit card balance transfer promotions available today. The strategy here is to transfer debt that you have on multiple high-interest credit cards to one card with a lower interest rate. For example, you might transfer the balances on three credit cards with interest rates of 16%, 19%, and 21% to a new card that has an interest rate of just 12%. Some credit card companies offer enticing promotions for balance transfers, such as no payments required for the first 6-18 months.
Many borrowers, particularly those unable to obtain unsecured loans, choose to use balance transfers to consolidate their debt. However, these lower interest rates are often short-term promotions; after 9-12 months, many of these cards raise these interest rates considerably. Borrowers should definitely read and understand a card’s terms and conditions before choosing this form of debt consolidation.
If you own a house or some other real property, you can use it to help pay off your debts. Borrowers with real property have two options when it comes to debt consolidation. First, if they have equity in their homes, they can attempt to refinance. If a home is valued at $200,000, for example, but is only mortgaged for $150,000, the borrower can attempt to refinance the home at $200,000. This would allow them to pay off the existing mortgage and use the difference – the $50,000 – to pay off any other outstanding debts.
Alternatively, borrowers could choose to obtain a home equity line of credit and use that loan to consolidate their outstanding debts. Borrowers with real property to use as collateral can often obtain debt consolidation loans where others are not eligible. However, there are risks; if a borrower with a secured loan defaults, or otherwise cannot make payments on the secured loan, the lender can choose to foreclose on the property.
Many options, each with pros and cons
Borrowers seeking to consolidate their debts have many options, each with its own advantages and disadvantages. Moreover, the debt consolidation process itself may not be the best option for many borrowers, depending on their current financial situation. Before choosing a method to address outstanding debts, borrowers should consult with a trusted financial expert. Doing so can help ensure that any decision they make to deal with their debt is the best one.