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Americans continue to be saddled with high levels of debt, especially when it comes to high-interest, revolving debt like credit cards. When viewed as a whole, the amount of debt American consumers carry is absolutely staggering. In fact, in the spring of 2021, the total amount of American household debt reached a staggering $14.6 trillion.
If you’re one of the households contributing to this massive debt, then chances are you are looking for ways to address it, or at least find a way to make that debt more manageable. One of the ways many Americans are tackling their debts is through debt consolidation.
Let’s take a close look at the process of consolidating debt, so you can see whether or not this process would be a good fit for you.
What is Debt Consolidation?
Debt consolidation is the payment of multiple debts by combining all the debts into a single new loan with the benefit of a more favorable debt structure. In most cases, consolidating your debts will help lower the overall interest rate you’re paying and lead to lower monthly payments as well.
Debt consolidation is a technique arranged to clear off small but multiple loans at one go by acquiring a single large loan with reduced interest. Through this technique, debtors get to pay only one large loan with reduced interest instead of paying multiple loans that are likely to drag them into default.
Debt consolidation is mostly used to combine several unsecured loans such as personal loans, and credit cards. However, some lenders do offer debt consolidation loans for automobile loans as well.
The process of debt consolidation is relatively straightforward. For example, if you had a personal loan and two credit cards, each of which held a $5,000 balance, you could apply for a loan from a lender for $30,000. Then you would pay off the credit cards and personal loan with the new larger loan so that each had a zero balance.
That would leave you with a new, single loan, presumably with a lower interest rate and longer repayment horizon. Consolidating your debt would leave you with just one monthly loan payment to manage, instead of three, and a lower monthly payment, which would make it easier to manage your debts.
Debt Consolidation Companies
There are a few debt consolidation companies to choose from. Two companies that have excellent reputations are:
How Debt Consolidation Works
If you’re thinking of consolidating your debts, you have several options. Traditional lenders are a great place to start, and many banks offer loans specifically for debt consolidation. However, if you’re only looking to consolidate credit card debt a balance transfer credit card is also a good option; these cards are designed for users to combine several different credit cards onto a new card that has a much lower interest rate.
You could also consider specialized debt settlement companies, such as National Debt Relief, which offer debt consolidation loans to individuals and corporate bodies. We’ll discuss these options in-depth later on.
However, before you apply for any debt consolidation loan, you should know the total debt owed to your various creditors, the interest you’re paying on the debts, and the repayment horizon for the debts. You need to know your credit rating as well since you’ll need a decent credit score to be able to get a new debt consolidation loan.
If you do get a debt consolidation loan, you should expect to make monthly payments against it, just like any traditional bank loan. This means that you’ll need a steady source of income that can handle the new loan, in addition to all of your other monthly expenses.
If handling a monthly loan payment is not possible at the current time, then debt consolidation is not a good choice for you.
As stated earlier, one of the significant demands for debt consolidation is that you have a good credit score. Your credit score is a clear indication of your creditworthiness, and your bank or any other institution would take this into consideration before offering you the debt consolidation loan.
If your credit is average, you may still be able to obtain a low-interest debt consolidation loan by taking out a secured loan. A secured debt consolidation loan uses some sort of valuable property, such as the equity you have in your home, as collateral for the loan. However, while you may be able to get that low-interest loan in this manner, the lender could seize your asset if you default on the loan. So, be aware of the risk.
If you have mediocre credit and no assets to secure a loan with, debt consolidation may not be a viable option. Similarly, if you don’t have the ability to make high monthly loan payments or have so much debt that you have no feasible way to pay it all off with your current income, then you will need to consider other options besides consolidation to tackle all of your debts. Working with a credit counselor, a debt settlement company, or in the most extreme cases, filing for bankruptcy may be more viable options to use to start addressing high levels of debt.
If you do determine you are going to get a debt consolidation loan, then you have several different options. For example, you could choose to obtain a personal loan, a balance transfer credit card, enroll in a debt management plan, or choose to work with a debt settlement company. Each one of these programs consolidates your debt in some form, but they all work differently from one another.
Let’s take a closer look at some of the most common debt settlement methods available today.
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Types of Debt Consolidation Methods
Personal loans are one of the most common forms of debt consolidation and it’s no surprise because most traditional lenders offer debt consolidation loans to clients. These types of loans are either secured by collateral, such as a home or automobile, or are unsecured.
A borrower with less than stellar credit would have a better chance of consolidating debt with a secured loan since the lender would consider this a less risky transaction. However, if you default on a secured loan your assets could then be at risk. An unsecured loan would carry no risk of asset seizure, but it would be difficult to qualify for one if you don’t have good credit.
RELATED: Best Personal Loans For Bad Credit.
Balance Transfer Credit Cards
Balance transfer credit cards are a popular way to combine the outstanding balances of multiple credit cards onto a new credit card, ideally with a lower interest rate. Using a balance transfer credit card can help lower the amount of interest you’re accruing each month, lower your monthly payments, and make debt repayment more manageable.
However, pay close attention to the rate your new card is charging, as well as its terms of service. In many cases these cards offer very low introductory rates for the first year or so, only to raise them significantly later on. If you inadvertently sign up with one of these cards with rising rates, you could end up in a worse debt situation than when you started.
Debt Management Plan
Debt management plans are usually offered by non-profit credit counseling institutions. These institutions work with borrowers to include their financial management skills and also work with creditors as well.
The major aim of the debt management plans credit counselors is to get lower monthly payments, lower balances due, or even at times get debts forgiven for borrowers who are hopelessly overwhelmed with debt.
They do this by negotiating with creditors on a borrower’s behalf. Not all credit counselors offer these services, but they can be extremely helpful for borrowers who have nowhere else to turn.
Also, many credit counseling services are nonprofits, so they offer debt management support for modest fees, and sometimes for free.
RELATED: How To Get Out Of Debt.
When using debt settlement, you hire a company to deal directly with creditors on your behalf. Much like debt management services, debt settlement companies work to negotiate better terms on your debt, with the aim of lowering your monthly payments, your balances due, or in some cases to get the debt forgiven entirely.
In doing so, you essentially sign over control of your credit accounts to the debt settlement agency as he or she works on your behalf to reduce your debts. This can be a great form of debt consolidation for borrowers, especially those who do not have the credit to obtain a traditional debt consolidation loan but still have a monthly income.
However, there are some drawbacks to working with a debt settlement company. You essentially lose control of your credit accounts for a period of time as the negotiations with your creditors are ongoing, and it could have an impact on your credit rating.
Additionally, there is no guarantee that the debt settlement companies will achieve more favorable terms with your creditors. Finally, these companies will charge customers fees or their services as well.
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When is it a Good Idea to Use Debt Consolidation?
Debt consolidation is great with awesome benefits for many consumers, but it is not a great fit for everyone. If your credit isn’t great, chances are that will narrow your options for debt consolidation considerably – if not close the door altogether. Not all borrowers necessarily need to consolidate their debts, either.
So, when should you combine all your debts? Here are a few ideas to know when it’s best to use debt consolidation:
- When you have good credit: If you have decent credit, it should be relatively easy to apply for a debt consolidation loan. If your credit isn’t great, you may have to consider one of the less traditional debt consolidation methods, such as debt management or debt settlement.
- When you have a valuable asset: If your credit is not great, you can still get a debt consolidation loan if you have a valuable asset, such as a home or a car. Using this asset as collateral for a secured loan can lower the perceived risk of creditors so that you can apply successfully for a debt consolidation loan. However, as stated earlier, there are risks to your asset if you should default on the loan.
- When you have steady income: If you have a steady income and can manage to pay all of your bills and the monthly payment of a debt consolidation loan, then this method of dealing with debts could be a good fit for you.
- When you have your spending habits under control: If you have addressed the root causes of your debts, and have your spending under control, then this can be a good method to deal with your debt. However, if you still are not budgeting your money effectively, then debt consolidation could make your financial problems even worse. If you haven’t addressed issues with budgeting your money, it may make better sense to talk to a credit counselor instead.
Pros and Cons of Debt Consolidation
The debt consolidation pros and cons are:
- Lower interest rates. Using debt consolidation to pay off your high-interest rate debts and having a large loan with a low interest rate will often lead to a lower monthly payment, and slow down how fast interest on that debt is accruing.
- Streamlined debt repayment. Debt consolidation lets you pay your debt with ease. It offers you an option to have all your multiple debts placed together and paid off with a single loan. Having multiple loans or credit card balances consolidated into a single account makes debt payment an easy process at the end. Debt consolidation solves the problem of having multiple payment deadlines by letting you have a single deadline, making debt repayment much easier to manage.
- Improves your credit: Debt consolidation gives your credit score the boost it needs. If you have one single monthly payment to contend with, you’ll be less likely to forget or miss a payment or pay your monthly bill too late. This should help you improve your credit rating over time.
- Longer payment horizon: While you’ll end up with lower monthly payments and lower interest rates, you’ll likely have a much longer debt repayment period with debt consolidation, which means you’ll stay in debt longer.
- Not available for everyone: If you’re a borrower with poor credit or have recently lost your job or are underemployed, you likely won’t qualify for any debt consolidation program.
Debt Consolidation Parting Thoughts
Debt consolidation can be a great way to help you address your debts and start paying them down. However, it is clearly not for everyone. So, make sure you talk to a trusted financial advisor to determine the best option for you to become debt-free forever.
Thanks for reading our debt consolidation article.
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