Debt Consolidation
What is Debt Consolidation?
You can eliminate credit card debt without taking out a loan. Debt management programs combine all of your credit card bills into one lower monthly payment with a lower interest rate.
Debt consolidation combines multiple debts into one payment with a better interest rate and more affordable monthly payments.
There are many types of debt consolidation programs, each with the goal of lowering the interest rate on your debt and reducing your monthly payments to a level you can pay off in 3-5 years.
Debt consolidation has three major benefits:
One Monthly Payment – Make one payment each month to one source. No more worrying about due dates and minimum payments. Debt consolidation simplifies the payment process.
Lower Interest Rates – Credit card interest rates can add hundreds, sometimes thousands, of dollars to your debt. Lowering your interest rate will reduce the amount you pay on your debt.
Pay Off Debt Faster – Debt consolidation programs reduce the time it takes to pay off your debt to 3-5 years. Paying off high-interest credit card debt by making the minimum monthly payment can take 10 years, or even longer in most cases.
The traditional debt consolidation approach is to get one large loan from a bank, credit union, or online lender and use it to pay off several smaller debts. This approach can work well unless you have a low credit score (in which case you may not be approved for a debt consolidation loan) or the interest rate on the loan is too high to do you any good.
If a low credit score is the reason you were turned down for a debt consolidation loan, then consider a debt management program, which is a simple and very effective way to consolidate debt.
Debt management programs offer the same benefits as a debt consolidation loan—lower interest rates and monthly payments—but without the hassle of a loan. Plus, your credit score is not a consideration for joining.
Debt management is a program offered by a nonprofit credit counseling agency, such as InCharge Debt Solutions, that consolidates your credit card debt into one monthly payment with an interest rate of around 8%.
How to Consolidate Debt
First, you need to determine the best way to consolidate your debt. As mentioned above, debt can be consolidated through loan or non-loan methods.
If you don't qualify for a debt consolidation loan or don't have a high enough credit score to qualify for a low-interest loan, then your best option is a debt management program offered by a nonprofit credit counseling agency.
Consolidate Debt Without a Loan
Start by calling a nonprofit like InCharge Debt Solutions and getting a free credit counseling service.
A credit counselor will review your budget, analyze your debt and recommend the best debt relief solution for your situation.
If you have enough income to cover basic living expenses and make your monthly payments, you may choose to enroll in a debt management program.
Nonprofit credit counseling agencies negotiate deals with credit card companies to significantly reduce interest rates and relax fees through their debt management programs (note: this is not a negotiation to "solve debt" - a solution used by for-profit debt settlement companies).
Once enrolled, debt management programs are designed to automatically make payments to credit card companies and pay off your debts within 3-5 years.
Consolidate Debt with a Loan
Make a list of the debts you want to consolidate.
Next to each debt, list the total amount owed, the monthly amount due and the interest rate paid.
Add up the total amount owed for all debts and put it in one column. Now you know how much you need to borrow with a debt consolidation loan.
Add up the monthly payments you currently pay on each debt and put that number in another column. This will give you a comparison figure for a debt consolidation loan.
The next step is to contact a lender and apply for a debt consolidation loan (sometimes called a personal loan) to pay off all of the debt you owe. Ask what the monthly payments will be and what the interest rate will be. Finally, compare how much you currently pay each month to what you would pay with a debt consolidation loan.
What debts can be consolidated?
Debt consolidation loans are primarily used to manage and pay off credit card debt, but they can also be used to pay off debts such as:
Credit card debt
Unsecured loans
Medical debt
Overdue utility bills
Collection accounts
Payday loans
Debt management plans primarily consolidate credit card debt, which is the most common reason to consolidate debt. But you can also add overdue utility bills, collection accounts, payday loans, and medical debt for “payment convenience.” In other words, the interest rate won’t be lowered, but consolidating these debts can make bill payments easier.
One thing to consider is that there is no interest rate attached to medical debt and utility bills. Taking out a loan (which will accrue interest) to pay off debt that doesn't accrue interest may not be a good idea.
A debt management program can help you pay your bills without letting those debts accrue interest.
Secured debts such as homes, property, and cars can be refinanced, but they are not candidates for debt consolidation.
Debt consolidation options and their pros and cons
Debt consolidation is good for some people, but not for everyone. Debt consolidation comes in many forms, each with its own pros and cons that could make your situation worse.
Because everyone's financial situation is different, it's best to take the time to research each option and find the one that works best for you. Here are the pros and cons of seven debt consolidation options.
Debt management programs
Debt management is a nonprofit form of debt consolidation that reduces your monthly payments and interest rates without taking out a loan.
A credit counselor works with your creditors to get you a fixed monthly payment that you can afford. People who participate in debt management programs have a 55% success rate. By making monthly payments on time, you can eliminate your credit card debt in 3-5 years.
Pros of Debt Management:
Credit counselors can get lower interest rates from your creditors, often reducing rates from 20%-25% or even higher to 8% or lower. Joining a debt management program will discourage harassing calls from debt collection agencies. A structured plan will give you a deadline to work toward. You can schedule monthly payment due dates. Participating in a financial literacy program can teach you how to save money, build an emergency fund, and set achievable financial goals.
Personal Loans
Banks, credit unions, and online lenders offer personal loans to consolidate debt. The loan is used to pay off all credit card debt, and the borrower only has to make one monthly payment, with the same interest rate and due date. The downside is that these loans require a good credit score, which can be difficult to achieve if you are already in debt.
Pros of Personal Loans:
The interest rate should be lower than the credit card rate. According to the Federal Reserve, the average interest rate for personal loans in 2022 is 9.58%, while the average interest rate for credit cards is 15.5%.
Personal loans are for a fixed amount of money paid over a fixed period of time. Credit card balances are revolving and constantly changing, which makes it difficult to calculate interest costs and when to pay them off. Personal loans, also known as debt consolidation loans, can be used to pay off any type of unsecured debt.
Balance Transfer Cards
Many companies offer credit cards that allow you to transfer your balances to a new card and enjoy 0% interest. You must have a good to excellent credit score (above 680) to qualify. The 0% interest is called the "introductory rate" and usually expires after 12-18 months. The interest rate on the card then jumps to between 15% and 25%. Transfer fees and late fees may also be charged. This can be a risky move unless you are sure you can pay off all your debts during the introductory rate period.
Advantages of a balance transfer:
No interest is paid for a year, sometimes up to 18 months, so you have time to eliminate your debt without paying interest.Consolidate all your credit card debt into one payment.
Balance transfer cons:
When the 0% rate expires, the new rate may be higher than your previous rate. Most cards have a balance transfer fee of 1%-3%. Clearing balances on other cards means more available credit. If you use that extra credit, you risk going into more debt.
Borrowing from a 401(k)
The rules for this vary, but generally you can borrow up to 50% of your retirement funds, up to $50,000, and pay it back over five years. The interest rates are low (usually prime rate plus 1%), but there are risks. There are tax consequences and penalties for withdrawing money from your 401k, and you lose a lot of the compounding power that helps your account grow. Only consider this as a last resort.
401(k) loan pros:
No minimum credit score requirement, no loan application. The lowest interest rate you can get. Repayment will be deducted from your paycheck.