A debt consolidation solution combines multiple debts into one, saving you interest and helping you become debt-free faster. However, not all options are equal. Some could even harm your credit score or saddle you with high interest and hidden fees. Instead, you can choose the right debt consolidation option by considering interest rates, terms, costs, and your financial goals. Read on to find the ideal debt consolidation plan that suits your needs
Debt consolidation solutions are usually new loans that streamline your multiple debts. That means you’ll want to be as careful when selecting debt consolidation as you would when choosing any loan. Consider the following factors.
Interest rates
Look for a low interest rate. When you switch three credit cards with 26%, 17%, and 18% interest to one loan with a 15% interest rate, for example, you pay less in interest. That means more of your cash is going to pay off the loan amount, getting you out of debt faster.
The tricky thing is that you only qualify for the best interest rates if you have a great credit score. You might not get the best rates if you have a lot of debt or have already missed a few payments.
When looking at interest rates, also consider whether you’re applying for a fixed-rate or variable-rate loan. Fixed-rate loans mean your interest rates and monthly payments don’t change. With variable rates, you may enjoy a lower rate when set interest rates are low, but this can change.
Loan terms and conditions
A longer repayment term means you have longer to pay off your loan and will enjoy lower monthly payments, but you’ll pay more in interest overall. A shorter term will save you money in interest but your monthly payments will be higher. Paying more each month, if you can, is the best option.
Consider the flexibility a debt consolidation solution gives you, too. Can you change the repayment schedule if your financial situation changes? Can you make extra payments without paying penalties? These features can help you pay off your debt faster and save on interest.
Fees and costs
Watch out for origination fees—the upfront costs that some lenders charge for processing the loan. Or, lenders may charge you balance transfer fees for transferring your debt from another company. Look for loans without these extra costs, where possible, and with low penalties for late payments.
Impact on your credit score
Debt consolidation can improve your credit score by lowering your total debt amount. When your monthly debt payments are lower, you can also make your payments more comfortably on time, which also boosts your credit score.
You need to be aware, however, that in the short term your credit score will temporarily go down because the lender will run a hard credit check to process your loan. Don’t apply for other financing around the same time.
Comparison of Different Options
The personal loan market in the United States is worth $356 billion, so it’s no surprise there are many possible solutions on offer. Here are the main options to consider:
Debt consolidation loans vs. balance transfer cards
These are among the two most common ways to consolidate debt. Debt consolidation loans are essentially private loans you can use to pay off most kinds of debts. You can borrow larger amounts, often up to $100,000, and for longer terms (as long as you have a good credit score).
Balance transfer cards are credit cards that come with a low introductory rate or even a 0% rate for a few months to a year. Just transfer your debt onto the card and pay off the card in full before the interest rate goes up. Some are only for credit card or other unsecured debts.
It’s usually easier to qualify for a balance transfer card than for a traditional loan. However, these cards usually come with a balance transfer fee—typically 3-5% of the amount you transfer. In addition, if you don’t pay off the full amount before the interest rate goes up, you could be stuck paying a very high rate.
Home equity loans vs. personal loans
There are two kinds of debt consolidation loans: secured and unsecured. Among the most popular secured loan options are home equity loans. These allow you to borrow against the equity of your home.
The advantage is that you enjoy some of the lowest interest rates on debt consolidation loans with a home equity loan, and you can usually borrow a larger amount and have years to pay it off. The big disadvantage is that you risk your home if you can’t make your monthly payments.
Unsecured personal loans don’t require you to risk your home, but they come with shorter repayment terms and higher rates than home equity loans. Since you don’t need a home appraisal, the application process is usually faster.
Credit counseling and debt management plans
You have options besides new loans. Credit counseling allows you to meet with a professional who can help you create a budget and give you advice on getting out of debt. Your first consultation is usually free. If you need more help than a budget and a plan, your counselor may suggest a debt management plan (DMP).
With a DMP, a credit counseling agency will contact your creditors and try to reduce interest rates. The agency will also combine your debts into one monthly payment. It can take three to five years to pay off your debts this way, and during that time you may need to close your credit accounts.
Debt management plans will temporarily lower your credit score and usually come with setup and monthly fees, but they can help you get out of debt without a loan.
Now that you understand the options, how can you choose the right fit? You need to start by looking at your current debts and your unique financial situation. Then, compare your options. Here’s how to do that:
Consider Your Current Financial Situation
Determine how much you can afford to repay each month and whether you can afford to pay more toward your debts by downsizing or taking on extra work.
Also, consider how much you need to repay and what kinds of debt you have. A few thousand dollars in credit card debt that you can repay in a few months can be handled with a balance transfer card. Tens of thousands of dollars in car financing, tax debt, and other debts may be better served with a home equity line of credit, personal loan, or credit counseling.
Calculate Your Potential Savings
You’ll also want to ensure you’re saving money with any potential debt consolidation. Start by listing your current debts. Include the total balance for each debt, as well as your monthly payment, the length of time you have to repay the loan, the interest rate, and any additional fees you’re paying.
Next, compare potential debt consolidation solutions by making a list. For each option, write out the interest rate you’d pay on your consolidated amount, the monthly payments, any fees, and how long until you’re debt-free.
Now, compare each solution with your current situation. If you owe $50,000 in total and currently pay $300 monthly for loans ranging between 15% and 20%, how much would you save in total if you could pay one monthly fee of $250 and pay only 12% in interest? Weighing your current situation against debt consolidation solutions will help you decide what will get you out of debt sooner.
Don’t forget to consider the total costs of a debt consolidation loan, including fees and total interest, as well as the potential monthly savings.
Check Lenders’ Reputations
After identifying a money-saving solution, verify the reputation of any potential lender or credit counseling agency. Always read online reviews to find out what other customers have experienced. Look for reviews compiled by editorial professionals and reviews with lots of detail since these will give you the most useful information.
Also, check the Consumer Financial Protection Bureau (CFPB) consumer complaint database and the Federal Trade Commission (FTC) website for any complaints and legal action against a company.
For debt consolidation lenders, contact your state financial regulation department to check the lender is licensed to lend funds in your state.
Credit counselors should have valid, current Certified Credit Counselor (CCC) or Accredited Financial Counselor (AFC) certification. This shows a credit counselor has completed training and testing and has agreed to abide by professional ethics standards.
When you’re facing a pile of debt, don’t feel discouraged. If you’re having trouble making minimum payments, reach out to debt consolidation professionals or lenders so you can make an informed decision about your next steps.
Remember, though—the right debt consolidation for your best friend or parent may not be the right fit for you. To find a way to get out of debt, always weigh different debt consolidation solutions by considering the interest rates you’ll pay, the fees, the monthly payments, the terms, the total costs, and the reputation of the lender or credit counseling agency.
Your goal is to find a legitimate solution that will save you money, make it easy to make monthly payments, and, ultimately, allow you to get out of debt easily.