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Getting Out Of Debt

A simple guide to debt consolidation

Most of us have some form of debt, and for many, it can sometimes feel like an uphill battle to put a dent in it, especially when carrying it from multiple sources. Although it certainly helps, there’s more to paying off debt than cutting back, earning more, and contributing every extra penny you have.

It’s common to hear warnings against taking out one loan to pay off another, but if the new loan is better and can help you pay off debt faster, it might be your best choice. Debt consolidation can help you save time and money by lowering your interest rate and the terms of your finance.

Here, we’ll delve into the basics of debt consolidation, as well as the risks and benefits that come with it.

What is debt consolidation?

Debt consolidation is when you combine several current debts into a single new debt. While you still need to repay the money, debt consolidation can make paying your debts simpler because you’ll have fewer bills each month.

You may also end up paying less money overall by getting a lower interest rate. It can be a good idea to look for savings opportunities when market interest rates have fallen, or when your credit score has improved.

Some loans are marketed as debt consolidation loans, but the name refers to how you’ll use the money rather than a specific type of loan. Lenders will generally send the approved funds to your bank account, and you can subsequently pay off other loans or credit cards using that money.

Personal loans are commonly used for debt consolidation. These loans are often unsecured, meaning a lender will approve you based on your credit background and you don’t have to put up collateral, like your car or home. However, a home equity loan, home equity line of credit, and cash-out refi are all secured loans that use your home as collateral.

Using a balance transfer on a new credit card is another way to consolidate debt, but beware there are often fees to initiate a balance transfer. Additionally, the new APR can increase after one missed payment.

Debt consolidation terms to know

If you’re shopping around for a debt consolidation loan, it’s important to compare each of the following terms to get the best deal.

  • Fees: The most common fees are origination fees on installment loans or balance transfer fees on credit cards.

  • Repayment period: Lenders usually offer a variety of repayment periods or terms. A longer term can lower your monthly payment, but it means more interest paid in the long term.

  • Interest rates: Interest rates are the price you pay to borrow money and are a percentage of the total dollar amount that’s loaned to you. Interest rates are generally shown in annual percentage rate (APR) ranges, and can also be either fixed or variable. Having good credit can help you get the best rate. If you qualify for a lower interest rate than you're currently paying, you can save on interest each month and put those savings toward paying off your loans sooner.

  • Secured and unsecured loans: Secured loans offer lower rates at the cost of using collateral (like a home). It’s best usually not to consolidate unsecured debt with a secured loan. But, because unsecured loans aren't secured on your home, interest rates tend to be higher.

Types of debt consolidation loans

Lenders may call certain loans debt consolidation loans, but almost any type of loan or line of credit can enable you to consolidate debt.

In general, debt consolidation loans fall within one of three categories. 

  • Unsecured personal loans: With these, you usually receive the full loan amount upfront and then repay the loan with fixed monthly payments over the repayment term. With a low interest rate and fixed payment amount, personal loans are a popular option for consolidating high-interest credit card debt. A personal loan with fixed-payment structure over a set period of time can also help put a debt-free endpoint in sight.

  • Secured loans: Some people turn to secured loans, often home equity loans or lines of credit, to consolidate debts. These may give you low interest rates, but the lender can collect your collateral (e.g. your home) if you miss payments.

  • Balance transfer credit cards: Credit cards may offer a promotional 0% interest rate on balance transfers to a new card. This means you won’t have to pay interest on a debt for the promotional period. 

If you have federal student loans, there’s also a special federal Direct Consolidation Loan.

You can also consolidate debts with a secured home equity loan (HELOAN) or home equity line of credit (HELOC). However, these often require an application that can be as complex as applying for a new mortgage.

If you’re struggling to afford your monthly payments, consider exploring a debt consolidation loan with a longer term. While this may lower your overall monthly payment amount, it may also increase how much interest you wind up paying over the life of the loan.

How can debt consolidation loans save me time and money?

Here’s an example of how a debt consolidation loan might help a borrower who’s carrying a lot of debt. Say you have $2,000 left on an auto loan with a 7% APR and four credit cards with a total balance of $6,000 and an average 22% APR. Each month, you pay $250 for the auto loan and $400 for the credit cards to cover both the accrued interest and a portion of your principal balances.

Suppose you get approved for an $8,000 personal loan with a 6% APR. You could use the money to pay off the auto loan and credit cards. Now, you only have one monthly payment, saving you the time and hassle of managing multiple bills each month. Plus, the lower interest rate will save you money.

Depending on your loan’s repayment term, you might also have a lower monthly payment, freeing up room in your budget to pay off your loan sooner, or for other expenses and savings.

Some lenders may provide you with several loan options and let you pick your term. A longer term will lead to lower monthly payments, but as previously mentioned, it could also cost you more in interest overall. Or, you could choose a short repayment term with a higher monthly payment, which can enable you to pay off the debt faster and with less interest.

The risks of getting a debt consolidation loan

Losing collateral isn’t the only risk you take from consolidating debt. In some cases, people will consolidate credit card debt and then wind up having to use their credit cards to make purchases and get back into debt.

Continuing with the scenario above, suppose you paid off your four credit cards with your debt consolidation loan. Now, you have four cards with $0 balances. If you’re an impulsive spender or are facing a financial setback, you might start using your credit cards without being able to afford the full monthly payments.

Given that the underlying goal of debt consolidation is getting out of debt, using a debt consolidation credit card for subsequent purchases, especially ones that don’t fit into your budget, can defeat the overall purpose. Not to mention, you’ll now have both your debt consolidation loan to repay plus new high-interest credit card balances. Ouch.

What to do before consolidating your debt

Before you consolidate debt, it’s important to get to the bottom of why you’re in debt in the first place. There’s no judgment here—we all know how life has a way of throwing unexpected curveballs our way that sometimes have unfortunate financial consequences. And, once you’re in debt, it can be easy to get caught in what feels like a never ending cycle of repayment. 

If you’ve accumulated a large amount of debt because you’re spending more than you’re bringing in, it’s important to reduce your spending or increase your income regardless of whether you go the debt consolidation route. If you suspect that irresponsible spending habits will follow you once you’ve consolidated your debt, it’s probably a good idea to take a hard look at how you can break those habits, as well as assess any underlying factors regarding why you developed those habits in the first place.

If you think you’ll overspend with a debt consolidation credit card, you can work with a nonprofit credit counselor or a paid financial advisor to build a payoff plan that you’ll stick with.

It can also be helpful to reach out to your lenders to request that they lower your payments. Although they are not obligated to do so, some may be willing to reduce your interest rate, lower your monthly payments, reduce or waive fees, or extend the terms of your loan to give you more time to pay.

How can I get a debt consolidation loan?

If you think you can manage a debt consolidation loan, look around at different lenders offering them and review their terms to find the fit that’s best for you and your budget. Debt consolidation loans are available from online lenders, P2P lenders, traditional banks, and credit unions.

Start your search with a wide net, as you might not know ahead of time which lender will give you the best offer. Lender A might have the lowest advertised APR, but Lender B could be the one that offers you the lowest rate.

Narrow down your options based on the following criteria.

  • Qualification requirements: Make sure you can get approved for a loan by reviewing the lenders’ basic requirements. There could be limitations based on where you live, your credit scores or history, and how you plan to use the money.

  • Maximum and minimum loan amounts: Make sure the lender offers loans for at least as much money as you need, and look to see if there’s a minimum loan amount as well. However, know that you might not get approved for as large of a loan as you want.

  • Interest rate type: Lenders may offer either a fixed-rate or variable-rate loan. Variable-rate loans tend to start with a lower interest rate, but the rate (and your payments) could rise in the future. If you want certainty, a fixed-rate loan may be better.

Look for online reviews and comparisons of lenders to learn about other borrowers’ experiences and see which lenders could be a good fit based on your creditworthiness. Also, be strategic about your applications.

Strategically getting the best debt consolidation loan

Generally, lenders will review your credit reports when you apply and a “hard inquiry” gets added to your credit history. Hard inquiries stay on your credit reports for two years and impact many credit scores for up to a year. Each hard inquiry can lower your credit scores a little, and multiple inquiries in a short period may increase the negative impact.

However, some lenders can conditionally pre-approve you for a loan with a soft inquiry which won’t impact your credit scores. You’ll still have to submit an official application and agree to a hard pull before receiving an official offer, but trying to get pre-approved can help you weed out lenders that might not be good fits.

Then, compare your estimated loan offers to your current debts. Create or update your budget with a plan for paying off the debt consolidation loan or balance transfer card, and build in some wiggle room in case you can’t stick to the exact plan every month. Having a plan in place up front and focusing on your end goal of paying off the debt in full can help you commit to making your regular payments.

After getting pre-approvals and identifying potentially good lenders (including ones that don’t offer pre-approvals), submit official applications starting with the lender that you think is best.

Depending on the credit scoring model the lender uses, multiple hard inquiries that occur within a 14-day (sometimes up to a 45-day) window might only count as one hard inquiry for credit scoring purposes. Additionally, the scoring model may ignore inquiries from the previous 30 days. So, try to submit all your applications within a two- week period to limit the impact on your credit scores.

Once you accept a loan offer, many lenders can transfer the money directly to your checking account. You can then use those funds to pay off your current debt and then focus on repaying your debt consolidation loan.

If done responsibly and with the proper due diligence, debt consolidation is one of the most common ways that people who carry significant debt can get out of a financial hole and make progress with their debt. By saving you time and money via lower interest rates or terms, as well as potentially leading to better spending and saving habits moving forward, debt consolidation can help you work toward a healthier financial future.


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