Here’s what debt consolidation is and isn't. Find out whether it’s the best option for you.
Debt consolidation may be able to help you pay off what you owe faster and more conveniently, with one payment instead of many. But there are different options for debt consolidation, and not all of them work the same way.
The first step is understanding what debt consolidation is,and isn’t. Then you can decide whether it makes sense for you, and which method may be a good fit.
Debt consolidation allows you to replace many smaller debts with one larger one, for example, transferring all your credit card debt to one card or line of credit, or taking out one loan to pay off multiple debt balances. Either way, you owe one creditor instead of several. Some considerations to remember are that debt consolidation may come with a lower interest rate (although not always) and a longer payoff term, which may mean you pay more overall.
Debt management means developing a plan to pay off your debt, typically with the help of a credit counselor, who may also be able to negotiate payment terms with some creditors. After paying a set up fee, you then make payments to the counseling agency, who distributes your payment among the card issuers. There are resources and lists of nonprofit agencies available through the National Foundation for Credit Counseling.
Debt settlement involves relying on a debt settlement company, to whom you pay a fee, to negotiate with creditors to accept less than what you owe. Why would lenders agree to a settlement? Sometimes they may believe the debt would be otherwise uncollectible or that you might file for bankruptcy. Some considerations here are that this method can be expensive and comes with risk, including fees, possible scams and lawsuits, and a lower credit score.
A low-rate credit card
A DIY debt consolidation option is to use a balance transfer offer to move one or multiple credit card debts onto a credit card you already have. Or, if you have good credit, you could apply for a new low-rate card. Key information to note is how long the rate will last, since that number is rarely fixed. In addition, piling a big balance on a single card may hurt your credit score. If you can pay the balance off quickly, there may be better options.
An unsecured loan
A loan from a bank may help you pay off your debt; it usually comes with fixed rates and a fixed payment length. They are typically unsecured by collateral or property, so you usually need a credit score that qualifies as “good” to get one. However, you will want to balance the interest rate with the payback period to ensure you don’t pay more overall.
A secured loan
These loans are guaranteed or “secured” by property; the most familiar types are a home equity loan or a home equity line of credit. When you take a loan against your home, you must make the payments or risk losing your home, and that debt may also not be in bankruptcy. (Loans secured by your car—title loans—or your paycheck—payday loans—typically have very high interest rates and predatory terms.)
A retirement plan loan
A 401(k) loans is a choice to take money from your retirement savings and also agreeing to pay it back with interest. There are limits to how much you may take and how quickly you must repay it. In addition, not all 401(k) plans allow 401(k) loans. Read more about the specifics of a 401(k) loan.
Credit scores are a way for potential lenders to evaluate your risk and potential to repay any loan they may give you. In general, higher credit scores may equal a lower interest rate. You can obtain a free copy of your credit scores from either an existing credit card company or a site like Credit.com. While there are a variety of options online to apply for different types of loans, you may also consult with a local lender like a bank or credit union.
Debt consolidation isn’t an option for everyone, including:
You have a low credit score
Generally, credit scores below about 620 may equal a much higher interest rate.
A high debt-to-income ratio
In general, if you have a debt-to-income ratio of about 30%, it’s typically assumed you’re able to easily pay off debt and still have income for living expenses.
A version of this article originally appeared on Her Money.
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