Types Of Debt Consolidation Loans

Loans generally fall into two main categories: secured and unsecured debt. Let’s start with secured loans.

With this type of loan, the borrower is required to back it with a valuable asset as collateral, such as a house or a car. In the event of default, the lender can seize and sell the property to collect the money owed. Since the risk on these loans tends to be small for lenders, the interest rate is typically lower.

Unsecured debt doesn’t require collateral. Instead, lenders issue these loans based on your creditworthiness and promise to repay. In the case of default, the lender must initiate a lawsuit to try to collect the funds due.

Since these loans are riskier for the lender, they tend to have stricter credit scores and debt-to-income ratio requirements and charge higher interest rates. You typically need a credit score of at least 670 to qualify , according to Equifax. The higher your score, the lower the interest rate.

Taking out a loan is the most common and well-known form of debt consolidation. Essentially, your new loan is equal to the total amount of your current debts. You use it to pay off all your creditors at once and then focus on paying down the new fixed payment. Since loans tend to have much more forgiving interest rates than most other forms of debt, especially credit cards, a debt consolidation loan can save you a great deal in interest over time.

Interest rates on debt consolidation loans typically range from 6 to 36 percent. The exact rate you will be offered is based on your unique financial history and credit profile. The best time to consider using a debt consolidation loan is when you want to reduce the interest rate on multiple credit cards and pay down balances faster. Another reason is if you are having difficulty staying on top of making payments to multiple creditors and prefer making only one monthly payment.

Requirements

You should be at least 18 years of age and not have any involvement in bankruptcy or foreclosure proceedings. Every lender will look at your credit score, income, and debt-to-income ratio to determine how capable you are of repaying the loan.

You need a minimum credit score between 580 and 680 to get a debt consolidation loan that offers reasonable rates, in most cases. If you also want to get one that does not charge an origination fee, you will likely need a credit score of at least 660, according to Wallet Hub.

Remember that the lower your credit score, the higher your interest rate will be since borrowers with poor scores pose a bigger risk of defaulting.

Not every type of debt consolidation loan is the same. Below, we explore three common types: personal loans, 401(k) loans, and home equity loans.

• Personal loans
  A personal loan is your typical bank loan. It is generally unsecured, meaning it doesn’t require collateral, and it usually comes with a reasonable interest rate. These qualities make it an effective and lower-risk vehicle for consolidating debt.However, the best personal loans are for borrowers with excellent credit. If you have been struggling with debt for a long time and your credit has suffered, you may not qualify for a decent interest rate. And if your credit is exceptionally low, you may not qualify for an unsecured loan at all.

  Requirements
  The best personal loans typically require you to have fair credit — usually between 580 and 669. Good and excellent credit above 670 will provide the best chance of approval with a competitive interest rate. Lenders will also consider your credit history, income and debt-to-income ratio.

• 401(k) loansWhile it is possible to take out a loan against your 401(k) to consolidate your debts, it is generally not a great idea. Admittedly, there are some tempting pros in favor of 401(k) loans: the interest rates are low, it doesn’t count on your credit report, and you are essentially borrowing money from yourself.

  That said, borrowing money this way could significantly hamper your ability to save for retirement, as you will reduce both the balance of your 401(k) and the interest that compounds over time on that balance. Past that, there are significant taxes and penalties that may be associated with early withdrawal. Be sure you talk to a professional to understand such consequences.

  You need to be careful to ensure you properly categorize your taking money from your 401(k) as a loan. Speak with your accountant before doing anything that could cause penalties. Finally, if you lose your job before you pay back the loan in full, you may only have 60 days to do so. Given the circumstances, this could prove difficult if not impossible.

  Pay Off Your Debt

  Requirements
  The maximum amount you may take out is generally 50% of your vested account balance, or $50,000—whichever is less. For example, if your vested account balance is $10,000, you can borrow up to $5,000.

• Home equity loans
  For homeowners, taking out a home equity loan (or a home equity line of credit) can be an attractive option for consolidating debt. If you have paid off a significant portion of your mortgage, you can borrow against that equity—up to 85% of your home’s value, minus outstanding mortgage payments.Borrowing against home equity can be a great option because it generally comes with lower interest rates than other types of loans. It also doesn’t require a credit check like a personal loan would.

  Home equity loans come with their fair share of downsides, however. They can take up to 30 long years to pay off. If you can’t keep up with the payments, you might lose your house, which is what secures the loan. Still, this is worth looking into if you are a homeowner.

  Requirements
  Whether you need extra cash for home improvements, debt consolidation or even travel, you are generally free to use the funds as you see fit.

If you have access to a loan with a decent interest rate and reasonable monthly payments, this is generally a safe, responsible choice.

If you have poor credit and lack a significant amount of home equity, this is probably not your best option. You usually won’t qualify for a loan with forgiving interest rates and may end up paying more in the end just to consolidate your debt.

Balance Transfer Credit Cards

For smaller amounts of debt, balance transfer credit cards can be ideal. With this option, you could open a new credit card that is offering a promotional interest rate (ideally 0% for a year or more). You then transfer your other credit card balances to the new card and pay off as much as you can before the offer expires and the interest rate skyrockets.

This process essentially freezes interest on your debts since every dollar goes towards paying down your balance. In this manner, you can pay down your debt much faster and enjoy the convenience of one monthly payment. Please note that balance transfers usually include an upfront cost (i.e. a fixed percentage of the amount being paid off).

Balance transfer credit cards work best for individuals with good credit and smaller amounts of debt since the limits on balance transfer cards only go so high. In other words, if you struggle with large amounts of debt or your credit has taken a plunge over the years, this option isn’t for you.

Debt Management

Debt management plans (DMPs) are not technically debt consolidation in the same manner as personal loans or balance transfer credit cards. Instead, a credit counselor, who is usually part of a non-profit organization, administers a plan to help you to get a handle on your finances and responsibly resolve your debt.

First, you meet with the credit counselor to comprehensively go over your finances. Once they fully understand your financial situation, they might simply help you make a budget. But more often, the counselor will draw up a debt management plan.

The counselor may negotiate with your creditors in an attempt to lower your interest rates and get any fees or penalties waived. Over the course of the plan, you usually make a single payment to the credit counselor, who will then disburse the funds to your various creditors.

Debt management is a popular choice for many people because it is accessible, educational, and understandable. Unlike personal loans or balance transfers, there are no credit requirements to speak with a credit counselor, and there is no limit on the amount you owe.

Over the course of the plan, you will learn how to manage your finances more responsibly and save for the future. Debt management’s one monthly payment is simple to follow, and your counselor can answer any questions you may have.

Debt Settlement

Debt settlement is not a form of consolidation. This could be your best option if you are in a real financial hardship with little ability to qualify for the loans referenced above. In fact, you could end up settling your debts for less than the original amount enrolled. If your debt is more than 50% of your income, debt settlement could be your best option.

With debt settlement, you make a single monthly payment into a dedicated savings account in your name. The debt settlement company will typically work to act as a buffer between you and your creditors.

Once a large enough sum has accrued in the savings account, the debt settlement company begins to negotiate with your creditors. The company will offer your creditors a lump sum payment on your balance or a “term” settlement that could require settlement payments for multiple months.

They are often willing to work with you to come to some sort of resolution rather than not receive any payment at all. In the ideal scenario, you settle your debt faster and for less money than you might have otherwise. Admittedly, your creditworthiness is usually negatively affected if you are not making monthly payments to creditors during the course of the program.

Reputable debt settlement companies like National Debt Relief only handle unsecured debts like credit cards, personal loans, medical bills, cellphone bills and rent payments. They do not deal with secured debts such as mortgages, auto loans, child support and past-due taxes.

The outcomes for debt settlement can be impressive. You could resolve your debts in a shorter amount of time by making minimum monthly payments and for less than the original amount enrolled. For this reason alone, many people struggling with debt choose debt settlement over other options. Please note that success depends on your making regularly scheduled payments on time.

Whether you are ready to choose a form of debt relief or you need further guidance, National Debt Relief is here to help.