With the US economy officially in recession and historic unemployment figures, many people are feeling the pressure. According to a recent NextAdvisor poll, more than half of all Americans have felt anxiety about their personal finances in the past few months, with debt being a major contributor.
Although debt is a part of the daily life of many, it can snowball and become big problems when you fall behind on your payments. But there are things you can do before you get too behind on your debt. Debt consolidation can be a way to reduce the interest rate or the monthly payments on your current obligations. But it’s not for everyone, and with so many different ways to consolidate debt, you should think about what might make sense to you.
What is debt consolidation?
Debt consolidation is the process of consolidating all of your debt into one payment, often with a loan or a credit card balance transfer.
“Typically, with debt consolidation, you are also looking to lower your interest rate. So it would be [to] save money and take the hassle out of it, ”says Ted Rossman, credit card analyst at Creditcards.com. When done right, debt consolidation can help you get out of debt faster and save or rebuild your credit.
Debt consolidation should not be confused with debt settlement, which every expert we spoke to said to avoid if possible. “When you settle for less than you owe, it’s a bad thing for your credit score,” says Rossman. “And also, a lot of these companies will try this tactic of telling you to stop paying for a while.” Debt settlement companies will use the fact that you don’t pay off your debt as leverage to negotiate a smaller repayment, says Rossman. However, there is no guarantee that this strategy will work, and even if it does, an account settled for less than what you owe will negatively impact your credit report for seven years.
How to consolidate debt
There are six different ways to consolidate debt, but the financial tools you can use fall into two main categories: secured and unsecured.
A secured loan is secured by something of value that you own, such as your house or your car. Unsecured debt has no underlying asset or collateral attached to it. With secured debt, if you default, the lender can take your house or other physical asset. For this reason, unsecured debt, like that on a credit card with balance transfer, is a better and safer way to consolidate.
Secured loans are less risky for a lender than unsecured loans, so they can have better interest rates and terms. But that doesn’t mean that a secured loan is always the best option. A Home Equity Line of Credit (HELOC) may have a better interest rate than your current debt, but if you can’t pay, your home is in danger.
Choosing the right debt consolidation strategy depends a lot on your financial situation. The catch is, to get the best interest rates, you need to have a high credit rating. And those in dire financial straits may not even be able to qualify for some of the best debt consolidation options, like 0% APR credit cards or low interest personal loans.
Lenders are worried about the future of the economy, so they are implementing stricter standards for balance transfer credit cards, home equity lines and personal loans, Rossman said. “Unfortunately, it’s a tough time right now for debt consolidation because a lot of the normal tracks have dried up or they’re just more difficult to qualify,” Rossman said.
How to consolidate debt
1.0% APR Balance Transfer Credit Cards
While they’re getting harder to find right now, some credit cards have introductory 0% APR offers on balance transfers for a set period of time, typically 12-18 months. If you can take advantage of these card offers, you can save on interest. For a balance transfer card to make sense, you must be able to repay the debt during the 0% period. Just keep in mind the balance transfer fees (3-5%) which can eat into your savings. If possible, request a card with no balance transfer fee and 0% APR.
2. Debt consolidation loan
Taking out a personal loan from a bank or credit union is another potential option for debt consolidation. A personal loan will have a fixed interest rate, which is an advantage over a variable rate credit card. Your credit score, income, and debt will determine the interest rate you can qualify for. So, before you apply, shop around to make sure that you will actually save money by getting a personal loan with a better interest rate – and be aware of the upfront set-up fees which can be as high as 8% of the loan amount. . Finally, if you have federal student loans that you want to consolidate, you may not want to use a personal loan because you would lose some protections that private loans do not offer, such as forbearance options or loan plans. income-based reimbursement. .
3. Credit counseling agency
Working with a nonprofit credit counseling agency is a great way to get free or low cost help with your debt. Credit counselors can give you free advice on budgeting or money management and even set you up with a Debt Management Plan (DMP) for a small fee. A DMP is similar to a debt consolidation, but instead of taking out a loan to pay off your debts, you make a payment to the counseling agency, and they pay your creditors. As part of a DMP, your credit counselor also negotiates with lenders for reduced interest rates or fees. Just be aware that if you choose to go with a DMP there will be a charge. Typically, the setup fee is around $ 50 to $ 75, and the monthly administrative fee ranges from $ 25 to $ 50. In addition, you are generally required to close your DMP credit card accounts.
If you don’t have the credit score to qualify for 0% APR balance transfer credit cards or low interest personal loans, consider credit counseling. You may be able to save without dipping into your retirement funds or putting your home at risk.
4. Secured loans
Consolidating debt with a secured loan is an option that you will want to consider carefully, and probably as a last resort. Obtaining a secured loan is less risky for the lender, so you may be able to get a better interest rate. But there is a big downside for you if you default. You should therefore only consider this route if you have a secure source of income.
5. HELOC (Home Equity Line of Credit)
The most common type of secured loans are those attached to a retirement account or to a home. If your home is worth more than you owe, you can take out a home equity loan, set up a Home Equity Line of Credit (HELOC), or refinance a cash-out mortgage to turn that value into cash to consolidate your home equity. debt. When mortgage rates are low, as they are now, it can be a great opportunity to save. But don’t miss any payments: If you default on a loan secured by your home, the lender could foreclose on your property.
6. Retirement accounts
If you have money invested in a retirement account, you can either take out a loan or withdraw the money earlier (i.e. make a distribution), depending on the type of account. This is usually a big no-no, as it can derail your retirement plan, lead to penalties, and make you more vulnerable in the long run. The money in your retirement account is usually protected against bankruptcy.
When debt consolidation makes sense
Debt consolidation makes sense if you have multiple loans or credit cards with high interest rates. Combining them under one interest rate could save you money in the long run. It also helps in daily debt management. If you’re juggling multiple payment deadlines, then it’s easy for one payment to slip through the cracks and damage your credit score. Debt consolidation also makes sense for those who already have a repayment plan and a sustainable budget.
When debt consolidation isn’t worth it
It’s not worth consolidating debt if you can’t get an interest rate lower than what you’re already paying. There is a fee involved in taking out a new loan or initiating a balance transfer, and if the interest rate is not competitive, potential savings could be lost through the fees. Debt consolidation is also not beneficial when you don’t have a plan to pay off that debt. This is not a quick fix – you will still need to be diligent with your budget and make your payments on time and in full.