When you’re in debt, you may feel like you’re in a deep hole from which you can’t climb out. If you have debt from loans and high-interest credit cards that you’re paying the minimum amount due, and you’re using your cards to pay for everyday items such as food, that hole just keeps getting deeper and deeper. The light at the top seems to keep getting further and further away.
There’s a way out!
Debt consolidation can be the ladder that gets you out of that hole.
What Is Debt Consolidation?
Debt consolidation consolidates your debt into one loan. If you have high levels of debt, it’s likely that the interest rates on your credit cards have risen due to late payments. The hope with a debt consolidation loan is that the loan has a lower interest rate that will save you money. The monthly payment would most likely be less than the sum of the monthly credit card payments as well.
The Main Considerations Before Agreeing to a Debt Consolidation Loan
In Before Getting a Debt Consolidation Loan, Ask Yourself These Three Questions, we discuss considerations that should be made to determine whether a consolidation loan is the best tool to help you get out of debt.
1. Have I made lifestyle changes?
A debt consolidation loan isn’t going to fix everything magically. You need to understand what actions and behaviors got you into your financial situation in the first place. If you don’t do a little self-examination and reconciliation, you’ll repeat the behaviors and get yourself further into debt. For a debt consolidation loan to work, you can’t add more debt to the pile. Debt consolidation isn’t a windfall. The loan may save you money, but you’re still going to have to work hard to pay it off. You’re not out of the woods until you come out the other end.
2. Is this the right loan?
Several types of loans exist that you could use to consolidate your debt. Should you tap into the equity in your home? This may be a good idea if you have equity, but you also need to understand that you may be putting your house on the line if you can’t keep up with the payments. Whether you refinance your home or get a home equity loan, you’re tying your home to your ability to pay the debt. Depending on the market, if you cash in your equity and later want to sell your home, you may find that the value is less than what you owe on it. Additionally, keep in mind that if you have a 30-year mortgage with 20 years left to pay on it, refinancing your mortgage means that you’re paying that added loan amount for the remaining life of the loan, meaning 20 years. It won’t save you money in the end; in fact, it could cost you a considerable amount more.
If tapping into your home’s equity isn’t an option, or it’s too much of a risk for you, you may choose to take out a personal loan. The rates for personal loans are usually lower than what your credit cards are charging.
Before deciding which type of loan would be best for you, work out the numbers for each option. Your financial institution–or financial advisor if you have one–can help you do this. Your advisor will consider other things as well, such as the fact that you may need Private Mortgage Insurance (PMI) if you don’t have 20% equity in your home after you refinance.
3. Do other options exist?
Don’t just jump into a consolidation loan because it seems like an easy solution. There are other options, such as aggressively paying off the debt yourself or working with a debt management company.
One of the benefits of a debt consolidation loan is that it puts your debt into one simple payment. When you have several loans or credit cards with different due dates and payment amounts, it can be easy to miss a payment or fall into a state of denial about the amount of debt, both of which will end up costing you money.
What to Do Before You Apply
In Can I Get a Debt Consolidation Loan with Bad Credit?, we explore the Catch 22 you may find yourself stuck in: you need a loan to get yourself out of debt and improve your credit, but you can’t get a loan because you have bad credit.
Before you apply for the loan, get a copy of your credit report. Your report has a lot of information on it but lenders are typically interested in five key factors, which, not coincidentally, are the five major components of your credit score.
- Payment history (They want to make sure you pay on time)
- Credit utilization (They want to know how much of your available credit you’re actually using)
- Age of your accounts (They like to see a long history of managing credit responsibly)
- A mix of credit accounts (They like to see a variety of revolving and installment loan types)
- Application history (They want to know if you’ve been shopping around for credit)
All these factors are looked at, but lenders weigh your payment history most heavily.
Even if you know your credit score is subpar, it’s important to check your credit report before you apply for the loan. There could be errors on your report that’ll cost you the loan or a good interest rate.
There are several reasons why you could have errors on your report. For starters, you could’ve been the victim of identity theft without even knowing it. The credit bureaus rely upon your creditors to report your information accurately, but mistakes do happen. Sometimes, credit files are mixed up between people with similar names and addresses. If one of your debts went into collections, the collection agency may “start the clock over” with your account.
Any of these errors can be disputed with the credit-reporting agencies, but the process can take some time, as they have to verify the accuracy of the information with your creditors. Additionally, keep in mind that you’ll have to dispute them separately with each credit-reporting agency, namely TransUnion, Experian, and Equifax. Most lenders will use credit reports from all three agencies so they’re getting the most complete picture.
While you’re going through the process of fixing errors on your credit report, be sure to continue to make your payments on time. That way, when you do apply for your debt consolidation loan, you have the best credit score possible to help you get the loan.
Finding the Right Debt Consolidation Company
How to Find a Reputable Debt Consolidation Company gives useful tips on finding a legitimate company to work with for a debt consolidation loan. There are many companies out there, all eager for your business. While most are legitimate, running to the first one that has an enticing offer could be a costly mistake. Interest rates and fees can vary greatly among banks and loan companies; if you’re going to save money by consolidating your debt, you have to shop around and calculate the costs for all your options.
Refinancing your mortgage or taking out a home equity loan through your bank or other financial institution might save you the most money. Alternatively, perhaps the best option may be to work with a company that focuses mainly on debt consolidation loans and getting people out of debt.
Try not to act quickly out of desperation. Do the research and weigh all your possible avenues out of debt.
Make a list. Because you have debt, you probably receive a lot of mailers offering you amazing deals and rates. Each may or may not be legitimate, so you need to do your research on any company you’re considering.
Next, go to the Better Business Bureau website and look up each company. If it’s not accredited through the BBB, look elsewhere. Each accredited company will have a rating, a reason for the rating, and a spot for customers to leave a review. Also, check to see if the company is registered with the Association of Independent Consumer Credit Counseling Agencies and the National Foundation of Credit Counseling.
If you choose a non-profit organization, ask for documentation. Note: non-profit doesn’t necessarily mean lower fees.
When you’re speaking with a representative at a debt consolidation company, take note of how he or she talks to you and handles your individual financial situation. If the rep tries to rush you into making a decision today, tries to sell you services other than the one you want, and makes it sound easy and fast, then proceed with caution. These are all signs of shady business practices in this niche because it’s never easy or fast.
The Possible Outcomes of Debt Consolidation
Let’s say you’ve found the right company and applied for a debt consolidation loan. What happens now? In Debt Consolidation: What End Results Are Possible?, we outline the potential outcomes once you’ve applied for the loan.
This happens frequently. People with high debt typically have lower credit scores, so the loan company may feel that you’re too much of a risk. If you have a poor credit score, but you’ve been making on-time payments for a decent period, then you’ll likely be fine. The last thing lenders want to see, though, is a recent history of late payments.
You’re approved but for less than you needed
Say you have $10,000 worth of credit card debt and the lender only approves you for a $6,000 loan. Should you take it? It can still save you money, so figure out which cards have the highest interest rates and use the loan to pay those off.
Then, analyze what’s left. What are the interest rates on your leftover debt? How much would you need to pay per month in order to pay them off by the time your loan is paid off? Can you afford that? If so, get started! If not, look into an additional personal loan or see if you can do a balance transfer to put your remaining balances onto a lower interest card. Be sure to do the calculations to determine which option will save you the most money.
You’re the victim of fraud
Unfortunately, this happens all too often. Scammers prey on desperate people, knowing that they’re willing to take the risk for an outcome that’s surely too good to be true. Many even boldly advertise on TV and in the paper, so don’t assume that exposure equates to legitimacy. As they say, if it seems too good to be true, it probably is, so do your homework.
Some things to look out for are:
- High monthly service fees with little or no services being performed
- Lack of transparency
- The company dragging its feet in dealing with your debt
- The company only has a P.O. Box rather than a physical street address
You get the loan but continue to rack up debt
This will definitely happen if you don’t change your financial ways. Debt consolidation loans are a tool, but most of the work has to come from you. Even if your loan is saving you money, you still have the debt. It’s yours, and you have to deal with it by working hard to make your payments. If money is left over at the end of the month, be sure to save it. Start an emergency fund so you won’t have to accrue more debt if your car breaks down or you or a family member becomes ill. Even if you’re only able to put a few dollars each week into an emergency fund, it’ll begin to add up.
You make it!
This is the best outcome! You’ve not only gone through the debt consolidation loan process, but you’ve also taken the time to understand how you got into debt and learned what changes to make to ensure a bright financial future. Congratulations!
Working to get out of debt is a tough, but definitely worthwhile, job. What are you waiting for? Use these articles to get a head start and finally begin the journey towards ebcoming debt free.