Debt Consolidation vs. Personal Loan
It’s easy to get confused when financial terminology is involved. A debt consolidation loan and a personal loan serve the same purpose. They each can be used to pay off unsecured debts. A debt consolidation loan is a type of personal loan where a lender provides a single loan that is used by the borrower to pay off numerous debts.
Process for Obtaining a Debt Consolidation Loan
Cleaning up your credit report is the first step any consumer should take before applying for a debt consolidation loan.
Lenders look at your credit report and credit score for evidence you can or can’t repay the loan. The higher your credit score, the lower the interest rate the lender will charge for a debt consolidation loan.
You can obtain a free copy of your credit report at https://www.annualcreditreport.com. Look it over closely and make sure it accurately reflects your financial story.
Once you are satisfied with the information on your credit report, go to a bank, credit union or online lender and fill out an application for a debt consolidation loan. Be prepared with details about your income, employment, years on the job and any other relevant financial information that helps prove you can repay the loan.
The loan officer will use that information along with your credit score to determine if you qualify for a loan, what interest rate you must pay and any other conditions for your loan. It is best to apply to multiple lenders, so you have a chance to compare terms and conditions before making a final decision.
Difference between Debt Relief and Debt Consolidation
The terms “debt relief” and “debt consolidation” often are confused with each other because they belong to the same family of financial solutions, but there definitely are differences.
Debt consolidation is geared toward paying the full balance on your debts. It usually involves a debt management program or debt consolidation loan, both of which combine multiple bills into one monthly payment with the goal of eliminating debt over a 3-5 year period.
Debt consolidation through a debt management company involves adding up all your debts into one place and then paying the debt management company who in turn will pay off the debt over a span of a couple years. A debt consolidation loan pays off all your outstanding debts. Then, you are left with paying only the loan you took out from a bank with the incentive that the loan has a lower interest rate than the debt you initially owed.
What it comes down to is debt consolidation is a form of debt relief like debt settlement and bankruptcy. It is not entirely the same as stated before, but another option for consumers on their journey to becoming debt free.
Debt relief is tilted more toward paying a portion of debt and having the rest forgiven.
In situations when you might have a lot of unsecured debt other than credit cards (such as medical bills and personal loans) debt settlement or bankruptcy is an alternative.
Debt settlement is offering the lender a percentage of the debt owed (usually between 50%-75%) and hoping they will forgive the remainder of the bill. Debt settlement is usually done through a debt settlement company, though you could attempt to do it yourself.
Debt settlement companies attempt to get your creditors to accept less than the full amount you owe by offering a lump sum of cash. The way it works is that you stop paying your creditors, and instead pay the debt settlement company each month. When the debt settlement company thinks that they have enough cash to negotiate, they go to each of your creditors and try to make a deal.
It doesn’t always work out, and of course there is a fee. The debt settlement company will either charge you a percentage of your total debt, or a percentage on the amount eliminated through settlement.
Bankruptcy is a nuclear option of debt relief. You declare yourself unable to pay your debts and ask a bankruptcy judge to give you relief from creditors. Bankruptcy will end up staying on your credit report for 7-10 years based on which type of bankruptcy you declare. This in turn will affect everything from getting a loan for a car to signing a mortgage.
Filing for chapter 7 bankruptcy sometimes is a better alternative to debt settlement. In chapter 7 bankruptcy, debts are discharged, while assets, that are not protected, are sold off. You should hire a bankruptcy attorney to handle the proceedings and weigh your options.
Is Debt Management or Debt Consolidation Right for You?
If you are determined – and committed! – to eliminating credit card debt, either form of debt relief will work. Both require the discipline of making consistent monthly payments to succeed.
Because every person’s financial situation is unique, the real question to be answered is: Which form of debt consolidation works best for me?
To answer that, start with your credit score and see where that goes in determining the interest rate on a debt consolidation loan.
If your score is not 700 or higher, you most likely will be paying a double-digit interest rate. That rate may still be less than what you’re paying on your credit cards, but factor in the fees associated with the loan and you may be closer to a push than you realize.
Plus, there is no hiding from the lender. If you miss payments, they will come after you with liens, lawsuits and debt collection agencies until you pay them back.
Credit scores aren’t a factor in debt management programs. The nonprofit agencies that offer them will look closely at your income and expenses to see if there is room for affordable monthly payments that eliminate debt in 3-5 years. They usually are able to pull the interest rate on your debt below 10%, sometimes even down as far as 5%-6%.
Plus, if you decide at anytime you want to quit the program, there is no penalty. It’s not wise to walk away, but you can leave without fear of liens, lawsuits or debt collectors.
Every great player has a coach that they can lean on. Contact a nonprofit credit counseling agency to walk you through the steps on how to find a debt relief program that fits best with your situation.
Sources