Navigating the world of personal finance can be difficult even when life is going smoothly, so when things start to go wrong, it is easy to feel like you are drowning. And a lot of Americans are — in fact, the average American reports having about $38,000 in personal debt — and that does not include home loans, according to a study by Northwestern Mutual.
When debts start to close in over your head, and you are not sure how to deal with them, you may want to consider combining multiple loans into one — also known as debt consolidation — as a way to finally get rid of your debt.
Consolidating loans is a popular option but before you commit to anything, it is important to do your research beforehand. As with most things in life, it is not right for everyone. Entering into debt consolidation under the right circumstances could save your finances and clear your debt, but attempting to utilize debt consolidation under the wrong circumstances could end up costing you more money in the long term. So, before you start making phone calls, here is what you should know about debt consolidation and how to determine if it is the right course for you.
Knowing the basics of each form of debt relief before jumping in is important. Not only will it give you a better understanding of how each process works, it will also provide more insight into which option may be the best fit for you — and which ones are not. Here are the main three options you should be aware of:
#1 Debt Consolidation
Put broadly, debt consolidation is the act of rolling multiple debts into one, creating a single monthly payment. This can be accomplished in different ways, but the goal is always the same.
Consolidating debt properly makes your monthly payments simpler and easier to keep track of, and it also can lower your overall interest and save you money. It is considered a form of debt relief.
If you do not think it is right for you, there are two other main options for you to consider:
#2 Debt Management
With debt management, sometimes a credit counselor is all that you need to jumpstart your way out of debt. By finding and involving a trusted credit counselor, you can work side by side with someone who understands your situation and can analyze the variances of your specific financial situation. They can make recommendations, suggest alternative repayment methods, and more.
They may also be able to negotiate lower interest rates and fees on your behalf. In a nutshell, the way it works is you send them a fixed monthly payment each month and they ensure the money gets distributed and paid out appropriately on your behalf across your various debts.
#3 Debt Settlement
Debt settlement is the last form of debt relief we will cover but is not often recommended as a first choice. In fact, it is often the last choice one should consider for paying off debt. Is it essentially when your lenders agree to accept a smaller amount than the full balance of your initial loan. If you are close to filing for bankruptcy, you might have a chance at getting a debt settlement.
Tread carefully, though, because debt settlement can negatively impact your credit score and cause other problems. If you are considering debt settlement, speak to a debt counselor first to see if it is a viable option for you.
Types of Debt Consolidation
There are a few different methods to choose from with debt consolidation. Depending on your situation, some will work better for you than others.
#1 Credit Card Loans
Your other option is to consolidate all your debt onto one credit card. You will likely need good to excellent credit to make this work, as you are only gaining ground if your new card has low fees and interest rates.
#2 Personal Loans
You need good credit for this option, but sometimes taking out a personal loan to pay off your debts is your best option. However, take great care when choosing a loan and be sure to do the math.
Your loan payments will be locked in for years so make sure you are not paying more on your new personal loan than you were with your original debt.
#3 Secured Loans
Secured loans can be a risky debt consolidation option. Basically, you are replacing all your debt, secured or unsecured, with a secured loan that has collateral backing it up.
These loans can be taken out against your paycheck, your car, or even you home equity. Most credit counselors warn to stay away from this option, as you could lose your assets if you fail to pay the loan.
#4 Retirement Loans
Another risky option is to consolidate your debt by borrowing from your 401K or another eligible retirement account. The appeal of this option is that it does not require a credit check, but you could ruin your potential retirement options and end up with huge tax bills if you are not perfect with paying back the loan.
Who Qualifies For Debt Consolidation
Being approved for debt consolidation depends on a variety of factors: What kind of consolidation you have previously applied for, your overall debt to income ratio (DTI), and your credit.
It seems counter intuitive, but if you are in a bad place credit-wise, your options for consolidation may be more limited and you might not be able to move forward with your ideal method of debt repayment. If there is anything you can do to improve your credit score or overall financial situation before applying, try to do so.
Debt consolidation seems like a final effort to end your debt problems, but it’s actually much more effective if undertaken before you find yourself on the verge of bankruptcy.
If you can see your debt situation starting to get out of hand, consolidation should be on your radar, and if you feel your debt has already spiralled completely out of control, you may need to consider other options. Speak to a non-profit professional to make sure you are making the best choice you can and learn as much as possible before committing to any program.
Christine Yaged is a co-founding partner and Chief Product Officer of FinanceBuzz. Christine launches and scales brands. She is passionate about technology, digital marketing, and people.