How to Consolidate Debt. Certain steps or guidelines on how to consolidate debt are certain. But the problem is that many users don’t even know about this. So why not create a review and then share it for users to get the information that will be helpful? So after reading, you should then share this article with your friends and even family, so they can also get the information.
How to Consolidate Debt
Before you can then know how to consolidate debt, you should first know how it works. Once you know how it works, then you will then know how to consolidate debt. This will help you understand the article better.
How Debt Consolidation Works
When you consolidate debt, you can combine multiple debts, such as credit cards, medical bills, and also other unsecured loans, into one monthly payment with a lower interest rate. It can also be an effective financial strategy if you have debt that carries high interest and you are ready to stick to a plan to pay off that debt.
There are also several methods that you can use to merge and even pay down your debts using debt consolidation. Read on to understand your options and also choose the one that works best for you.
The Best Way to Consolidate Debt without Hurting Credit
Credit Card for Balance Transfer
Balance transfer credit cards usually come with a promotional 0% annual percentage rate (APR) on balance transfers for a set period of between 12 and 20 months. The idea is simply to transfer your debts to the new card and also be able to pay off that debt during the introductory period to avoid paying interest.
When considering using a balance transfer card to consolidate debt, ensure that the combined amount of debt you are transferring is lower than your credit limit. And do not forget to account for transfer fees and read the card’s fine print. You might even find that the APR for new purchases is different from the balance transfer rate, which can then end up costing you if you make new purchases on the card. Typically, it is best to use a balance transfer card only to pay your existing debt without incurring new debt.
If you do not think you will be able to pay most of the balance before the promotional period ends, check to see whether your new card’s ongoing APR is lower than the rates you are currently paying on your other cards. If it’s not, this option might not be the best way to deal with your debt.
A Debt Consolidation Loan
Another option for you is to simply get a debt consolidation loan that offers a lower APR than what you are paying on your current debt. If your credit score is in good shape, this type of personal loan can help you reduce your total debt by hundreds, or even thousands, of dollars by simply decreasing the amount you owe in interest.
For instance, let’s say you simply owe $10,000 in credit card debt with an average APR of around 22%, and you are currently paying $400 every month to meet the minimum payments. It would then take you a whopping 184 months to pay off this debt, and you would even end up paying $8,275.44 just in interest. Now, suppose you have been approved for a $10,000 consolidation loan with an interest rate of 11%. With a fixed monthly payment of about $217, you would then be able to pay off this loan in only 60 months and save over $5,200 in interest.
That said, if you have less than stellar credit, you might not even qualify for terms that would make a debt consolidation loan worthwhile. Before you simply get discouraged, however, shop around so you know all the options available to you.
Debt Management Plan
Debt management plans (DMPs) are programmes offered by nonprofit credit counselling agencies. They are simply designed to help those struggling with a large amount of unsecured debt, such as personal loans and credit cards. They do not cover student loans or secured debts such as mortgages or auto loans.
Before signing up for a DMP, you will simply go over your financial situation with a credit counsellor to see if this option is a good choice for you. If you decide it is, then the counsellor will simply contact your creditors to then negotiate lower interest rates, monthly payments, fees, or all of the above, and they will also become the payer on your accounts. Once they simply reach an agreement with your creditors, you will then start making payments to the credit counselling agency, which will use the money to pay your creditors.
When you agree to a debt management plan, you might have to close your credit cards per your credit counsellor’s requirements. You should also avoid applying for more credit, as your creditors will likely have to withdraw from the programme if they see new debt on your credit report.
Debt Settlement
While debt settlement might even seem similar to a debt management plan, this option can then present a much bigger risk to your credit. You can also try settling the debt yourself or hire a debt settlement company to do it for you for a fee (typically between 15% and 25% of the settled amount).
The goal is to simply negotiate a payment with your creditors that is even lower than your full outstanding balance. Paying less than you originally owed might seem like a great deal—until you consider the consequences for your credit, which could even be substantial. Additionally, the forgiven debt might then be reported as income to the IRS, which simply means you might have to pay taxes on it.
If you then work with a debt settlement company, it will usually require you to stop paying your bills while it simply negotiates your new settled amount, which is simply 50% to 80% of the total balance. Late payments will even be reported to the credit bureaus (Experian, TransUnion, and Equifax) and will also stay on your credit report for seven years. These accounts can then go into collections as you wait for your debt settlement company to complete negotiations. All of these actions will have a substantial negative impact on your credit.
That is why you should only consider debt settlement as a last resort. For example, it might then make sense if you already have accounts that are severely delinquent or in collections. Otherwise, look into some other methods to consolidate debt.
Borrowing from Home Equity or Retirement Accounts
These two debt consolidation methods are simply associated with the risk of not only your credit score but also your assets. They can then include borrowing against your house and also borrowing from your retirement account.
If you have equity in your house, you might be able to use a home equity loan or line of credit (HELOC) to get the cash you need to pay off your other debts. This method is popular because home equity loans and lines of credit offer low-interest rates as they simply use your home as collateral for the loan. But that is also where the danger lies: You simply risk losing your home if you default on your payments.
As for borrowing from your 401(k), you can then get up to 50%, or a maximum of $50,000, from your retirement funds. There is no credit check, the interest rate is low, and the repayment is deducted from your paycheck.
However, once you have pulled out the funds from your 401(k), they will then lose the power of compounding interest that allows your account to grow. Furthermore, if you simply do not pay back the amount in full, you might then have to pay an early withdrawal penalty and also income taxes on the amount withdrawn.
Because of the risks associated with these methods of debt consolidation, you may only want to consider them in a financial emergency or when other alternatives are exhausted.
How Debt Consolidation Affects Credit
In the long run, sticking to your debt payment plan can also help your credit scores. However, as you start to consolidate debt, you may see your scores drop. How long it will also take your scores to recover will then depend on the consolidation method you have chosen.
Here are the ways debt consolidation can affect your credit:
- New credit applications: When you apply for a debt consolidation loan or balance transfer credit card, the lender will check your credit, resulting in a hard inquiry on your credit report. Hard inquiries lower your score by a few points. However, your score should recover fairly quickly.
Adding new accounts to your credit file also reduces the average age of your credit, or how long you have maintained open accounts. This can impact your credit score and is one reason to consider keeping your paid accounts, which contribute to longer credit history, open. Instead of closing the accounts, put the cards in a drawer or somewhere you will not use them. - Change in credit utilization: Your credit utilisation ratio, or percentage of available credit you are using, also affects your credit score. The lower your ratio, the better for your credit, because this shows you’re not using up all of your available credit. If you then keep your old credit cards open after a balance transfer, your credit utilisation will likely decrease, benefiting your score. However, keep in mind that even a single card with a high utilisation rate—in this case, the balance transfer card you used to consolidate debt—might still have a negative effect on your credit. That is another reason to avoid incurring new debt on your balance transfer card by putting your old cards away so you are not tempted to use them.
- Debt management plan requirements: Signing up for a DMP may have a negative effect on your credit score as well. Even though the enrollment itself has no impact on credit scoring, your report will show less available credit as a result of closing your credit cards, which is often required by DMP counsellors. Your score might experience an initial drop but will likely recover if you follow the plan.
- Settled debts: Of the methods we’ve discussed, debt settlement presents the biggest risk to your credit score because you are paying less than the full balance on your accounts. The settled debt will be marked as “paid settled” and will remain on your credit report for seven years. The more debts you settle, the bigger the hit your credit score could take. In addition, late payments and even collections, which often occur when you use this method, will bring your score down.
Whichever debt consolidation method you choose, the most important step that you can take is to simply maintain a positive payment history by making all your payments on time. This can then help your scores recover from short- and medium-term negative effects and even improve in the long run.
FAQs
Is Debt Consolidation a Good Idea?
Consolidate your debt if you can, then simply get a loan at better terms and/or it will help you make payments on time. Just ensure that this consolidation is simply part of a larger plan to get out of debt and that you do not run up new balances on the cards you have consolidated. Read about how to tackle credit card debt.
Are there debt consolidation alternatives?
Yes, debt consolidation can even be an effective tool when managing debt, but it is not a magic bullet. There are some solutions you can try that do not involve taking out new credit or potentially damaging your credit score.
Do Debt Consolidation Loans Hurt Your Credit?
Debt consolidation can even help your credit if you make on-time payments or consolidate your credit card balances. Your credit might then be hurt if you run up credit card balances again, close most or all of your remaining cards, or miss a payment on your debt consolidation loan. Learn more about how debt consolidation affects your credit score.
How Can I Get All My Debt into One Payment?
Debt consolidation is also one way to be able to make paying off your debt more manageable. Instead of making several minimum monthly payments on a number of bills, this repayment strategy involves getting a new loan to then combine and also cover your other loans or debts. You can even repay all of your debts with a single monthly payment.
