Debt Consolidation

What Is Debt Consolidation?

Debt consolidation is a debt-relief option that combines multiple debts into a single payment with a more favorable interest rate and more affordable monthly payment. The result is that you pay off debt faster, while saving money.

There are several types of debt consolidation programs. The goal of each is to lower the interest rate on your debt and reduce the monthly payment to a level that you can pay it off in 3-5 years.

The major benefits of debt consolidation include:

1. A single monthly payment – One payment, to one source, once a month. No more worrying about due dates and minimum payment amounts.
2. Lower interest rate – Credit card interest rates can add hundreds – sometimes thousands – of dollars to your debt. Lowering the interest rate will reduce the amount of debt you pay.
3. Pay off debts faster – Debt consolidation programs reduce the payoff time for credit card debt to 3-5 years. Trying to pay off high interest credit card debt by making minimum monthly payments can take 10 years or, in most cases, longer.

How to Consolidate Debt

First, you will want to decide which debt consolidation strategy you are going to use. Debts can be consolidated with or without a loan.

You can find debt consolidation loans from banks and online lenders. Nonprofit credit counseling agencies offer a debt management program (DMP) that provides all of the benefits of a debt consolidation loan without having to take out new credit.

The best way to consolidate your debt will depend on your credit score and the interest rates available. If you have poor credit, a DMP will probably be your best bet. If you have good credit, you may be able to qualify for a debt consolidation loan, but be sure that the interest rate is competitive. In high-rate markets, loan rates soar, so it's worth comparing the loan offer to a debt management offer even if you have good credit.

Debt Consolidation Calculator

Use the debt consolidation calculator below to estimate how much you could save by consolidating your debt.

Which Debts Can Be Consolidated?

A debt consolidation loan is primarily used to manage and pay off credit card debt, but could also be used for the following debts:

• Credit Card Debt
• Unsecured Loans
• Medical Debt
• Past Due Utilities
• Collection Accounts
• Payday Loans

One thing to consider is that medical debt and utility bills don’t have interest rates attached to them. It might not be wise to use money from a loan (which will accrue interest) to pay off a debt that does not accrue interest.

Secured debts such as homes, property and automobiles can be refinanced, but are not considered candidates for debt consolidation.

Options for Debt Consolidation

Debt consolidation is beneficial to some people, but not everyone. It comes in several varieties, each one having plusses that make it appealing and minuses that might make your situation even worse.

Because every person’s financial situation is unique, it is best to spend time examining each option and find the one that is right for you.

Debt Management Plans

A debt management plan is a form of nonprofit debt consolidation that will reduce your monthly payments and interest rates without having to take out a loan.

Credit counselors work with your creditors and get you a single, fixed monthly payment that you can afford. The success rate for people enrolled in debt management programs is 55%. Make on-time monthly payments and you eliminate your credit card debt in 3-5 years.

Personal Loans

Banks, credit unions and online lenders offer personal loans to consolidate debt. It is also known as a debt consolidation loan.

The loan is used to pay off all credit card debt, leaving the borrower with a single monthly payment, interest rate and due date. The drawback is that these loans require a good credit score, which might be difficult to achieve if you are already in debt.

Balance Transfer Cards

Many banks offer credit cards that allow you to transfer the balance on your cards to a new card with a 0% interest charge. You must have a good-to-excellent credit score (above 680) to qualify for one.

The 0% interest is known as an “introductory rate” that expires, typically after 12-21 months. The rates on the cards then jump to between 20%-25%. There also is a 3%-5% transfer and late fees could be applied.

This could be a dangerous move, unless you are sure you can pay off all your debt during the introductory rate period.

Home Equity Loans

If you have equity in your house – it’s worth more than what you owe on it – you can borrow against that amount. The interest rates on home equity loans are lower than interest rates on credit cards, but there is a significant risk here: You could lose the home if you miss payments on this loan.

Borrowing from 401(k)

Rules vary on this, but usually, you are allowed to borrow up to 50% of your retirement fund to a maximum of $50,000 and pay it back within five years.

The interest rate is low (usually prime plus 1%), but there are risks here. There are tax consequences and penalties for withdrawing from a 401k before you turn 59.5 and you lose a lot of the power of compounding interest that helps the account grow. Only consider this as a last resort.

Debt Settlement

If your bills have reached the stage where they have been sold to debt collectors, this might be your only option. Debt settlement companies advertise that they will reduce the amount you owe by 50%, but when interest, late fees and program fees are factored in, the real reduction is closer to 25%.

Debt settlement becomes a severe negative mark on your credit report for seven years and will damage your credit score by 100-200 points. You also must pay taxes on any amount the lender forgives. Be careful of debt settlement, especially if you hope to buy a house or car in the near future.

When Debt Consolidation Is Worth It

If you aren’t sure whether you can pull yourself out of a financial mess, try an online credit counseling session. Be sure the agency’s credit counselors are certified by the National Foundation for Credit Counseling. Ask them to review your assets and expenses and recommend a course of action. The call is free.

If you are not a viable candidate for debt consolidation, they could recommend bankruptcy. Despite its reputation, bankruptcy is not a financial death sentence. It is a chance to start over and with the right direction from a bankruptcy attorney, you could be back on your feet financially in as little as two years.

Debt Consolidation Alternatives

Debt consolidation is not necessary every time you fall behind financially.

For some people, the unexpected loss of a job or an accident that brings on severe medical costs, is enough to create problems, but in most cases, people simply mismanage their money. They have enough income to manage everyday expenses, but overspend on things like houses, cars, vacation, clothing and eating out.

In either case, there are solutions that allow consumers to get back on their feet. Here are some of the alternative choices that can help stabilize your situation and eventually eliminate your debt.

Balance Your Budget

The most effective alternative to consolidating debt is learning to live on less than what you make. In other words, make a budget … and stick to it! Take the time to list income and expenses, then adjust those numbers until the column under “income” exceeds “expenses.” There are plenty of budgeting apps that should help make this process workable, if you are disciplined about it.

Do-It-Yourself (DIY) Debt Management Plan

Credit counselors work with credit card companies to lower interest rates. You could try doing to the same for yourself. You may not have the same leverage as someone with the backing of a credit counseling agency, but DIY debt management is worth a shot. Start by calling each of your card companies and asking them to lower your interest rate. Then, use a combination of the other alternative methods like balancing your budget and debt stacking.

Debt Stacking

Debt stacking, also called the debt avalanche method, is a DIY debt elimination strategy. Start by ordering your debts from the highest interest to the lowest. Next, pay the minimum balance on all of your credit cards and put whatever money is left in your budget toward the debt with the highest interest rate. Once that is paid off, move on to the debt with the next highest interest rate. The card with the highest interest rate is costing you the most money. Wiping out that card first will save you the most money.

Snowball Method

The debt snowball method is similar to debt stacking, but instead of ordering credit card debts by interest, order them from the lowest balance to the highest balance. Again, pay the minimum balance on all your cards. Then, use the rest of the money to target the card with the lowest balance. Once that card is paid off, move on to the card with the next lowest balance. This will help you pay off a single debt faster. The theory is that once you see a debt wiped clean, you will be motivated to continue paying off your other debts.

Credit Card Hardship Programs

This is the corporate alternative to a debt management plan, but it is more difficult to qualify for. Credit card hardship programs can reduce interest rates and monthly payments as well as waive late fees. However, these benefits are only available in “hardship” situations like job loss, severe accidents or long-term illness.

Bankruptcy

Bankruptcy is a last-ditch solution when no other debt-relief option will work. Chapter 7 is the most popular form of bankruptcy, but you must qualify for it by earning less than the median income in your state. The other form of personal bankruptcy is Chapter 13, which allows you to set up a 3-5 year payoff plan for your debt. The rule of thumb is that if you can’t produce a plan to pay off your debt (minus your mortgage) in five years, bankruptcy is a good choice. It gives you a second chance to get things right, but it comes at a high price. It will stay on your credit report for 7-10 years and make it difficult to get credit during that time.

» More About: Bankruptcy vs. Debt Consolidation

Signs You Should Consolidate Debt

• You are spending more money than you are making.
• Your credit card balances are growing, not shrinking.
• You’re making only the minimum payments on your debt.
• You have been turned down for a credit card or store installment loan for having a high debt-to-income ratio.
• You carry debt on more than 5 credit cards.
• You are approaching or are at your credit card limits.
• You carry a balance on credit cards with interest rates in excess of 18.99%.

Getting Started with Debt Consolidation

It might be difficult to choose which of the many debt consolidation options would work best for you. If that’s the case, make a phone call to the credit counselors at InCharge Debt Solutions and get a free credit counseling session.

The counselors are trained and certified in budgeting, consumer credit and money management. They will help you create an affordable monthly budget, review each of the debt-relief options, including debt management and debt settlement, and give you advice on which one will best suit your situation.

They are required to give you the best option or risk the company’s nonprofit status as a 501(c)3 agency.