Debt consolidation is an increasingly common strategy that consumers are using to address high levels of credit card and other debt. Typically, consumers obtain a debt consolidation loan from a lending institution and use it to consolidate all outstanding debts into one loan. When you consolidate debt, you’re left with a single monthly payment, which is often at a lower interest rate. The result is that it’s easier to manage your outstanding debt so that you’ll be in a better position to pay it off.
When consolidating debt with a loan, borrowers have two primary options to consider: secured and unsecured debt consolidation loans. A secured loan uses some sort of property as collateral, such as your home. The collateral makes it more likely you’ll qualify for the debt consolidation loan and get it at a lower interest rate. However, if you become unable to repay the loan, your property could be at risk. An unsecured loan doesn’t use any of your property, so you don’t have to worry about losing anything if you’re unable to keep up with monthly payments. However, unsecured debt consolidation loans usually require a high credit score to qualify, something that people struggling with high levels of debt usually don’t have.
This is just one example of how you can consolidate your debt. You can see a list of the other methods below:
- Option 1: Pay down the debts yourself
- Option 2: Get a debt consolidation loan
- Option 3: Transfer your balances
- Option 4: Settle your debts
- Option 5: Choose National Debt Relief
Since there are several different methods of debt relief out there, it’s important that you understand what each one does and seek out the type of help that’s right for your situation.
Pay down the debts yourself
Don’t believe anyone that says you can’t pay down your debts on your own. It’s entirely possible to muster the financial resources required to shrink and eventually eliminate your balances for good. To do this, you’ll need to pay down your debts one at a time. You could begin by working on the credit card with the highest interest rate while still making the minimum payments on your other credit cards. This is called the debt stacking method and is favored by many experts because over the long run it will save you the most money. However, it can take a long time to pay off a high-interest credit card especially if it has a big balance. You will have to persevere and just keep chipping away at it.
The second way to pay down credit card debt is called the debt snowball method. The financial wizard Dave Ramsey developed it. If you were to choose this method you would put your credit card debts in order from the one with the lowest balance down to the one with the highest and then put all of your efforts against paying off the one with the lowest balance.
The idea behind the snowball method is that you would be able to get one of your credit cards paid off fairly quickly and would then have extra money available to begin paying off the credit card with the second lowest balance and so on. We’ve seen examples where people were able to pay off $20,000 in debts in just 27 months using this method. Dave calls it the snowball method because as you pay off each debt you gain momentum for paying off the next credit card debt much as a snowball gathers momentum as it rolls downhill. A similar debt payoff method is called the debt avalanche. Both plans try to accelerate paying off your debt. They both can work if you can stick with them and have the money needed to pay off your debt.
Unfortunately, it’s hard to muster the requisite discipline to stay on schedule during a self-managed debt repayment plan. Such a plan might also require you to make uncomfortable cuts in your household budget or even to get a second job. You and your family just might not be willing to make such sacrifices.
Get a debt consolidation loan
Talk to a debt consolidation expert:
A second way to get debt under control and ultimately paid off is with a debt consolidation loan. If you own your home and have some equity in it you might be able to get either a home equity loan or a homeowner equity line of credit (HELOC). You would then use the proceeds from the loan to pay off all of your other debts. You would then have only one payment to make a month, which should be considerably less than the sum of the payments you are now making. The reason for this is that either one of these loans would have a much lower interest rate than the average of the interest rates you’re now paying. If you’re paying an average of 15% or even higher on your credit card debts and were able to consolidate them into a variable rate home equity loan, your interest rate could drop to 4% or less. And the interest on an interest-only HELOC might be even lower.
If you don’t own your home or if you don’t have much equity in it the alternative would be to get personal or unsecured loan. These are called unsecured loans because they don’t require you to use any asset as collateral to secure them. These loans typically have higher interest rates then secured loans and can be more difficult to get if you’re already having a big problem with debt.
Debt consolidation loan monthly payment examples
Before you rush out and take out a loan to consolidate all your debts into one low monthly payment you should check out how much it will cost you and how long it will take for you to pay it off. You need to make sure you’re going to actually save money with a lower interest rate compared to other options.
Let’s assume you take out one loan with one payment for these examples.
Debt Consolidation Loans For Good Credit Scores
For a $35,000 debt consolidation loan with a very good credit score between 740-799, you can expect an interest rate of around 10.99%. Here’s what your monthly payments could be with a lender:
$1146 for 36 months = $41,256 total cost over 3 years
$904 for 48 months = $43,392 total cost over 4 years
$761 for 60 months = $45,660 total cost over 5 years
$666 for 72 months = $47,952 total cost over 6 years
$599 for 84 months = $50,316 total cost over 7 years
For a $25,000 debt consolidation loan with a good credit score between 670-739, you can expect an interest rate of around 13.99%. Here’s what your monthly payments could be with a lender:
$854 for 36 months = $30,744 total cost over 3 years
$683 for 48 months = $32,784 total cost over 4 years
$582 for 60 months = $34,920 total cost over 5 years
$515 for 72 months = $37,080 total cost over 6 years
$468 for 84 months = $39,312 total cost over 7 years
Debt Consolidation Loans For Bad Credit Scores
Most lenders require a minimum credit score of 660 to qualify for a loan. Otherwise your interest rate would be too high for it to make financial sense to even take out the loan. The reason for this is consumers with low credit scores are riskier to lenders so they charge more fees and higher interest rates to compensate for that risk.
If you have a good credit score, you can find a company that doesn’t charge an origination fee but if you have bad credit, you can expect to find a 1% to 5% origination fee. Plus, you could have interest rates anywhere from 29.95% to 35.99% or even higher.
Here’s what a 35% APR would look like on a $10,000 loan:
$452 for 36 months = $16,285 total cost over 3 years
$390 for 48 months = $18,706 total cost over 4 years
$355 for 60 months = $21,294 total cost over 5 years (notice you’re already paying back twice what you originally borrowed)
$334 for 72 months = $24,033 total cost over 6 years
$320 for 84 months = $26,904 total cost over 7 years
Now compare these consolidation loan examples to what it would cost to use a program like National Debt Relief that helps you resolve your debt for less than the full balance and help you get out of debt in 24 to 48 months.
Transfer your balances
If you have multiple credit cards and especially if they’re high-interest cards another option would be to make a balance transfer either to a card with a lower interest rate or, better yet, a 0% interest balance transfer card. If you were able to transfer credit card debts that averaged 15% to a new one at 12% you would have a lower monthly payment and this could make easier for you to reduce your credit card debts. An even better deal would be to transfer those debts to a 0% interest balance transfer card, which would give you a timeout of anywhere from six to 18 months during which you would not be required to pay any interest at all. This means all of your payments would go against reducing your balance and if you were able to heavy up on those payments you could actually be debt-free before your promotional period ended. If this sounds like a good option be sure to read the fine print before you sign up for that new card. It could have a high transfer fee that would wipe out some of the savings you would achieve by transferring your debts.
You also want to check out what your interest rate will be after your promotional period ends as it could be as high as 19%. That wouldn’t matter much if you were able to get your entire balance paid off but if not you could end up right back in credit card jail.
Balance transfers and debt consolidation loans have one bad thing in common. Neither will do anything to reduce your debts. If you owed $20,000 and transferred it to a debt consolidation loan or to a new credit card with a lower interest rate you would still owe the $20,000. And while a debt consolidation loan might have a much more favorable interest rate it will cost you more over the long haul because it will have a much longer term. Home equity loans can be for as many as 30 years and a home equity line of credit is usually for either seven or 10 years. In comparison, if you were to choose to repay those credit card debts yourself, you might have them completely paid off in three years or less using the snowball method.
Settle your debts
A third way to achieve relief from those awful credit card debts is through debt settlement. It can be better than either a debt consolidation loan or a balance transfer because when done successfully it can actually reduce the amounts you owe. The way this works is simple – at least in theory. All that’s required is for you to contact each of your creditors and offer to make a lump sum payment to settle the debt but for less than its face value.
For example, if you owed $5000 on a credit card you could contact the issuer and offer to make a lump sum payment of $2500 to settle the debt. If you can prove that you are suffering from a serious financial hardship the credit card company might agree to settle for the $2500. You will need to have the documentation available to prove you really have a serious financial hardship including a list of all your debts, the amount you owe on each, the last time you were able to make a payment on them and any minimum payments.
You also will need to have a list of your assets and your earnings. The point here is that you must be able to prove beyond the shadow of a doubt that you simply cannot repay your debts and if the card issuer refuses to negotiate with you then your only option will be to file for bankruptcy.
In fact, in some cases you might lead with the threat of filing for bankruptcy or at least infer this is what you are about to do as that’s the most powerful weapon for getting a company to negotiate. Most operate under the old adage that half a loaf is better than none. Your job is to convince the credit card issuer that if it refuses to accept half of what you owe it’s likely that it will get nothing.
DIY debt settlement requires two other things. First you need to be very good negotiator as you will be up against people that are very shrewd and very experienced in debt negotiating. Second, and here’s the really tough part, you need to have the cash on hand to pay for any settlements you are able to negotiate. The overwhelming majority of credit card companies will refuse to negotiate with you unless you can immediately pay for the settlement in cash – either via a wire transfer or certified cashiers check.
Debt Consolidation vs. Debt Settlement
Debt consolidation loans help consumers by taking all of their debt and combining it into one loan with a single payment. Sometimes, with a lower interest rate, they can end up paying less per month than what they are currently paying to all their creditors. Moreover, making only one payment can make their monthly bills easier to manage.
By lowering their monthly outlay of cash and making their payments easier to handle, many consumers feel like they may be on the right track to getting their debt problem under control. While consolidation loans can be helpful in some cases, downsides exist that consumers should consider before making that step.
What are the risks of a debt consolidation loan?
There are several risks associated with debt consolidation. These can have significant long-term effects that can prove problematic for a consumer looking to solve their debt problem.
Risk of accumulating debt again
Consumers who have not put in the hard work and discipline to pay off their debt are at risk of repeating the same mistakes and ending up with an even bigger debt problem. In reality, debt consolidation loans only shift the debt into another form. Although it may be at a lower interest rate and have a lower payment, it is still going to take a long time to resolve.
Often times, after debt consolidation, consumers will find themselves accumulating credit card debt again very quickly. If they do not change their spending habits, the amount of monthly cash flow created with debt consolidation could dwindle quickly. Those who have never learned to budget and manage their money will find that very little will change for them with a debt consolidation loan. They will likely continue to overrun their monthly income and rely on credit cards to make up the gap.
If they have utilized the equity in their home for debt consolidation, things get even trickier. If they run up enough additional debt that they are unable to meet their monthly obligations, they are putting their most precious asset at risk.
Risk of paying more interest over the long run
Debt consolidation loans that utilize the equity in a consumer’s home, while yielding a lower interest rate and payment, will have a long loan term. Most mortgages have a loan term of 30 years; so, even with a lower interest rate, it is likely a consumer will pay more interest over the life of the loan.
If you are considering using the equity in your home, you should do the proper due diligence to determine if it is economically feasible and wise to roll credit card debt into your home mortgage. A few calculations to compare the interest you will pay utilizing different consolidation methods will give you a clear picture of the right scenario for you.
Debt consolidation, under the right circumstances, for the right consumer, may be a good option. However, for those who are running consistently behind each month and damaged their credit, it most likely going to be a tough road to qualify. Many times, as mentioned, consumers just can’t seem to budget their money effectively to stretch their dollars to make ends meet. This can make debt consolidation a bad option for them.
Consumers who are in significant debt and likely to have a hard time qualifying for a debt consolidation loan, and those who feel the risk of acquiring more debt and putting their home at risk is unacceptable, should consider debt settlement.
Debt settlement is a process of negotiating a full and final settlement with creditors to satisfy a debt balance. Companies such as National Debt Relief collaborate with consumers to reach a settlement that is acceptable to both parties. While it is not an easy or fast process, and it will have a negative effect on your credit, it does have the ability to completely eliminate your debt problem and save you from some of the pitfalls of debt consolidation.
The debt settlement process can also relieve considerable stress for homeowners who are struggling with oppressive debt by taking over the communication process and stopping collection calls to the consumer. Even though a consumer’s credit score may suffer, chances are strong that it already took a hit anyway, and the damage would certainly be not as severe or long lasting as a bankruptcy.
It’s important that consumers not wait too long to address a difficult debt situation. Otherwise, the options available to them could become very limited. It’s also important that consumers understand the dynamics of the options available to them so they are informed and able to make the best decisions for their financial future.
Debt Consolidation Loans and the Effect on Credit
Borrowers often use debt consolidation loans to address multiple outstanding debts. If you’re thinking about debt consolidation, one important consideration is the loan’s impact on your credit score. Using debt consolidation to pay down debts can often be beneficial to a borrower’s credit score. However, there are pitfalls, and you could end up lowering your credit score if you’re not careful.
Let’s take a look at debt consolidation and the effects it could potentially have on your score.
Ease of Payment Keeps You Out of Trouble
When you combine all your debts into just one loan, you’ll only have a single loan payment to contend with each month, instead of multiple bills due to several different creditors. A debt consolidation loan should, therefore, make it much less likely that you’ll have a late payment, or miss one altogether, as you’ll only have one payment to make each month.
Your ability to pay your bills in a timely manner – also known as your payment history – is the most important part of your overall credit rating, accounting for over a third of your overall score. Therefore, consolidating your debts will make it much easier to keep track of your debts and pay them on time, which should help your credit score.
A Boost to Credit Utilization
When you use a debt consolidation loan to pay off your credit card balances, it should also help you with credit utilization on your credit accounts. Credit utilization is the amount of credit borrowed against a particular credit account. Since credit utilization accounts for approximately 30% of your overall credit score, this is a very important factor when it comes to how good or bad your credit is.
If the balances on your credit cards had been high – over 30% of the maximum credit balance – paying them off with a debt consolidation loan can be quite beneficial. While not a hard and fast rule, utilizing more than 30% of your available credit on a credit card account is generally the point at which your credit card use will start to hurt your credit score. Therefore, paying those card balances off with a debt consolidation loan should be a big help to your overall rating.
Will your debt consolidation loan diversify your “debt portfolio?” If so, then just taking out a debt consolidation loan may give your credit score a slight boost. One of the five factors used to determine your credit score is credit mix, a measurement of the different types of debt you’re currently holding. Lenders like to see that borrowers can qualify for and manage different types of debt. If your previous debts have been limited to credit card accounts, getting a debt consolidation loan may help to raise your credit score a little. However, the key word here is “little,” because credit mix only accounts for about 10% of your overall credit score.
New Inquiries Can Lower Your Credit Score
When you apply for and then obtain your debt consolidation loan, you may notice a slight drop in your credit score immediately afterward. Every time you apply for new credit, a lending institution pulls your credit report to help it decide whether to grant you a loan. New credit inquiries comprise approximately 10% of your credit report, and each new inquiry can potentially have a negative impact on your overall credit score.
However, while obtaining the new debt consolidation loan may have a negative impact on your credit, that impact will not likely be significant; after all, other factors such as payment history play a much more significant role in computing your overall credit score. Additionally, since you’re using the loan to help you address multiple outstanding debts that’ll take time to pay down, your score should return to normal before you need to obtain new credit again.
Don’t Make Accidental Errors
If you plan to use a debt consolidation plan to address your outstanding debts, make sure that you don’t inadvertently damage your credit score in the process with simple mistakes. How you consolidate all your credit card debts can negatively affect your credit score. Borrowers often use balance transfers and move all of their credit card debt to a single card with a higher credit limit. However, in doing so, they may end up with a high credit utilization rate if they close the old accounts completely. For that reason, it makes sense to keep at least a few of the paid-off cards open, but be sure not to use them.
Building New Habits
Consolidating all your debts into a single loan will not erase the bad financial habits that got you into heavy debt in the first place. If you continue to make the same mistakes with debt after you obtain and use your debt consolidation loan, you may actually make your credit score even worse than before you started.
For example, if you decide to start using your credit cards again after you’ve paid them off, your credit utilization rate may skyrocket and sink your credit rating. Similarly, if you fail to pay attention to the due date on your debt consolidation loan and miss a payment, your payment history may take a big hit as well. So, make sure you’re prepared to address all the challenges you have with credit when you take out a debt consolidation loan; otherwise, your credit rating may pay the price.
You should expect your credit score to be lower while you’re working to get out of debt; after all, important credit score factors such as your payment history and credit utilization are likely key reasons why you’re working to get out of debt in the first place. While you should be concerned about your credit score, and monitor it at all times, a lower credit score is not a reason to panic. Remember, you’re considering a debt consolidation plan to help you manage your debts more effectively, which should help your credit score in the end.
Debt consolidation can have both positive and negative effects on your credit score. The loan’s effects on factors such as payment simplification, credit utilization, and credit mix may help raise your credit score slightly. Conversely, the new credit inquiries required to qualify for one of these loans may also lower your score slightly. However, as long as you have a sound plan to pay off your debts over time and implement your plan effectively, your credit score will improve over the long term.