Understanding Debt Consolidation

The concept of debt consolidation can be confusing to the average consumer. Dealing with mounting debt can be overwhelming and stressful. When the bills continue to pour in and money is tight, it can be difficult to cover all your financial obligations.

Many consumers find themselves in this exact situation.

Excessive debt can make it difficult to meet your payment deadlines each month. And then it negatively impacts your credit score.

Luckily, there are options available that can help ease your debt, and consolidation is one of them.

Combining several debts into one can be a sound tactic. It can to help you pay down your debt and make managing your budget easier. Further, it can help ensure that your credit score stays up where it should be.

Before we get too far into how it affects your credit, let’s breakdown what the term means and whether the service is a good fit for you.

What is Debt Consolidation?

Debt consolidation services offer various options for those who need help dealing with their debt. The goal is to consolidate several debts into one larger loan. Usually, this new loan will come with a lower interest rate, making it more affordable and easier to pay off.

By taking advantage of this arrangement, you can combine all smaller debts into one loan and have only one monthly payment. Technically, you pay all smaller debts off with funds from another loan source.

You would then use the new loan to repay all smaller loans, leaving you with only one single loan payment.

Consumers use debt consolidation loans typically to consolidate:

  • Small loans
  • Overdraft balances
  • Credit card balances
  • Bills
  • Personal loans

Pros and Cons of Debt Consolidation

Before you decide to participate in this program, it’s important to weigh the pros and cons of debt consolidation. You do want the debt relief option that best fits your situation.

Easier to manage one payment

If you take out a debt consolidation loan, you can eliminate the different debts you had in the past. Rather than having to manage several loans, you’ll only have one to deal with.

Lower interest rate

As already mentioned, you can take advantage of a lower interest rate in your loan with debt consolidation.

If the rate you get is lower than your current debts, you’ll save money on interest payments. The right debt consolidation option will typically lower the rate on your debt to about 10 percent or less.

Pay off debt faster

Lower interest rates mean more money saved. Which means more money available to pay down the principal portion of your debts. As such, you can pay off your debt sooner.

Avoid damage to your credit score

You can prevent adverse effects to your credit score with debt consolidation. Credit score damage usually comes with late or missed payments.

Prevent this from happening and you can keep your credit score where it is. And with a good credit score, you’ll have more options for securing loans in the future.

Cons of Debt Consolidation

This is the part where you may realize this option isn’t best suited for you. Or that it is, and you should heed the advice below. That way you can avoid any future problems.

May be difficult to get approval

If you don’t meet the qualifications, you cannot get a debt consolidation loan. This is especially true for unsecured loans. Many people who need one might not be able to qualify.

You could lose your assets on a secured loan

If you take out a secured debt consolidation loan, you could lose your valuable assets.

Whatever asset you use to secure the loan is at risk if you default on the payments. If you can’t repay the loan, you could lose your home, car, or other asset that you pledged for the loan.

Your credit score can suffer

If you are late on payments or miss payments on your loan, your credit score could suffer. This is true for any type of loan. Being late or missing debt payments is a bad thing for credit scores.

Debt Consolidation Options

You have a few debt consolidation options to choose from. Each option that you have available has its own advantages and disadvantages. As such, it’s important to review each before deciding which is right for you.

The option you choose depends on your financial situation. Let’s go over what these options are to help you decide which is the best route to take.

Credit Card Debt Balance Transfer

One of the biggest types of debt that consumers struggle with is credit card debt. If you’re struggling with credit card debt, then a balance transfer might be the answer for you. You can use balance transfer credit cards to move your outstanding balance to another card at a lower interest rate.

This will help you save on interest payments. Credit card interest rates tend to be higher when compared to other types of debt. And with a balance transfer, you can pay a lower interest rate.

Balance transfer credit cards usually come with introductory rates as low as 0 percent . If you have enough cash to pay off your outstanding balance, a lower rate means more money can go towards your principal and less to the interest. This can save you money and help pay off your balance sooner.

A credit card balance transfer is also a tool you can use to better manage your finances. This is especially true if you have outstanding balances on multiple credit cards.

Transferring your credit card balances to one issuer leaves you with only one monthly payment. That way you won’t have to deal with different interest rates on different credit cards.

But while there may be perks to balance transfer credit cards, there are also fees to know about. It’s important to find out what the fees are on the balance transfer credit cards you’re looking at.

A 0 percent balance transfer may sound like a good idea. But if you must pay a high transfer fee on your outstanding balance, it might not be such a great deal.

Balance transfer fees range from 1 percent to 3 percent of your outstanding balance. For instance, if you’re transferring a balance of $2,000, you’ll pay a balance transfer fee of $20 at 1 percent or $60 at 3 percent . Crunch the numbers before signing up for a balance transfer credit card to make sure it’s worthwhile.

Unsecured Debt Consolidation Loan

A debt consolidation loan is a tool that allows you to combine your unsecured debt. This includes credit cards, personal loans, utility bills, and so forth.

You can consolidate all these loans into one from a single lender. In turn, the lender will pay off all your unsecured debts.

A debt consolidation loan is best for those who have difficulty meeting some monthly expenses. It’s also great for consumers who want to reduce their total monthly credit card payments and have only one loan to manage every month.

This pays off all your lenders and creditors at once and is usually for a 60-month (5-year) period. You take out one large loan to pay off all other unsecured loans. That way, you’re left with one debt to manage instead of several.

Not only is having only one loan easier to manage, it can save you money too. This is especially true if you have plenty of high-interest debt on the books, such as credit cards.

In fact, credit card interest rates can be as high as 25 percent or higher. And if your outstanding credit card debt is very high, it can be difficult to pay it down with a high interest rate.

But if the rate on the loan is lower, you can reduce the amount you pay every month.

Home Equity Loan

If you own a home, you may be able to use your equity to consolidate debt

Home equity is the difference between your home’s value and the amount you owe on its mortgage. For instance, let’s say your home is worth $500,000 and you still have $300,000 left on your mortgage to pay. That means you would have $200,000 in home equity ($500,000 – $300,000).

Lenders who provide home equity loans require homeowners to have at least 80 percent equity in their homes. If you don’t have at least this much equity, a home equity loan is probably not right for you.

If you are eligible for this type of loan, you can use it to pay off all other debts. Your lender might allow you to take out this “second mortgage” to use up some of your equity for this purpose. You would then have two mortgages: your first mortgage and a second loan to serve as your debt consolidation loan.

It’s important to consider home equity loan rates before going with this option. This arrangement might only make sense if the interest rate you get is lower than what you already have. If your mortgage rate is quite low, then this might be a great option to consider.

You might be able to get the same interest rate on your second mortgage, but this might not always possible. Make sure it’s low enough to make mathematical sense.

With a home equity loan, you’ll likely have more flexible payment arrangements. You may even be able to extend your amortization period (the time required to repay the loan in full). This can help you reduce your monthly payments.

Debt Management Program

If none of the other debt consolidation options are appropriate for your situation, then a debt management program might be an option.  A debt management program consolidates all credit card payments into one monthly payment. Instead of paying your creditors, you will make one monthly payment to a credit counselling agency.

The credit counselling company will then use that money to pay off all your creditors. But your creditors will have to agree to this arrangement.

By taking part in a debt management program, your credit card debt can diminish within 5 years. It’s possible to pay it all off sooner than that. In fact, most consumers in this program pay them off in fewer than 3 years.

It’s important to note that a debt management program doesn’t relieve you of your debts. Instead, it helps you better manage them.

The great thing about a debt management program is that you can get rid of all your credit card debt. There’s usually a very low interest rate associated with this arrangement.

You can even repair your credit score if it’s been suffering. You’ll receive one-on-one help and can learn to budget better.

However, there are some downsides to debt management programs. The biggest disadvantage is that your credit score may suffer temporarily.

It may show on your credit report that you’ve participated in a debt management program. If that happens, your credit score may dip.

Also, it’s important to find out if there are any fees charged. If there are any, find out how much they are. While some credit counselling agencies only charge a small fee, others charge much higher fees.

What if I do not qualify for a debt consolidation loan?

A debt consolidation loan might be a great option to help you deal with your financial woes. But there is no guarantee you will get approved. In fact, there’s always a chance that you may not.

The following are five of the more common reasons for loan denial:

No collateral

It’s typical for lenders to ask for collateral when providing a debt consolidation loan. That means you will have to put up some asset of value to back up the loan. If you ever default on your loan, the lender can repossess the asset that you used to collateralize the loan.

Collateral is meant to protect the lender in case you default. But if you don’t have any collateral to use, that could be a reason for loan denial.

Poor credit score

One of the more common loan denial reasons is a bad credit score. A decent credit score is required when applying for any type of loan.

A good score tells lenders you have a good track record of making timely payments. But a bad score paints the picture of a riskier borrower.

Insufficient income 

Not only do you need a good credit score for loan approval, but you need a decent income too. Obviously, you need to be bringing in a certain amount of money to support your loan payments. If your income isn’t sufficient, you could be turned down for a loan.

Lack of credit history

Lenders want to see a lengthy and positive credit history. This will give them a better idea of what your credit history is like. But if you haven’t been using credit for very long, you won’t have much of a credit history for lenders to go on.

Too much debt

A debt consolidation loan is meant to help consumers who have a lot of debt that they need help managing. But sometimes the debt is so high that even a consolidation loan isn’t suitable.

Remember, a debt consolidation loan is still debt. This debt joins any other secured debt you have. If your lender considers your total debt load too much, they could deny your loan application.

If you do not qualify, there are other solutions you consider, including some of the above.

Get Help for Your Debt Issues Today

If you can’t seem to climb out of your debt, then debt consolidation might be the right option for you. Before you decide if this is the right step to take, make sure you weigh all your options. There are many programs designed to help consumers with their debt.

You might be drowning in debt, but there may be a way to fix your financial problems. Reach out for help and speak with an expert who can guide you in the right direction.

More Information about Debt Consolidation

If you’re currently having financial problems because of excessive credit card debt, don’t wait to find the solution you need. The following pages may provide additional information to help you make the right choice for your unique financial situation:

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