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What is Debt Consolidation?
Debt Consolidation is the act of using one loan to pay off numerous other loans. Even though these often get confused, Debt Consolidation is NOT the same as Debt Settlement (attempting to settle with creditors for less than you owe) or Debt Management/Credit Counseling (working with a non-profit company to work out a budget, repayment plan, lower interest rate, etc). It is simply exactly what the name states: “consolidating” several debts into one.
With Debt Consolidation, you are attempting to put all your debts together into one all-encompassing monthly payment. The idea behind it is that if you can consolidate all of your debts into just one that it will:
- Be easier to manage
- Be a lower payment than all of your current monthly payments combined
- Hopefully have a lower interest rate.
Best Debt Consolidation Options:
Any of these methods can be used to consolidate your debts. Really, you’re just using one of these methods or loans to pay off all of your other debts, and then your new monthly payment is to pay back this new loan.
Traditional Bank Loan:
Most people considering debt consolidation options aren’t in a position to qualify for a traditional bank loan, especially not one with a decent interest rate. If you are able to qualify for a loan from your bank, or even better, a credit union, this is definitely your best option. It doesn’t have the same risks or drawbacks associated with some of the other methods.
Low Interest-Rate Credit Card:
Again, many people won’t be able to qualify for this. If you can qualify for one of the low-interest rate credit cards it might be a good option…if you will actually be disciplined enough to pay it off. If not, absolutely stay away from this option. You want to stay away from creating yet another problem and debt.
Home Equity Line of Credit:
If you have equity in your home, you might be able to take out a Home Equity Loan. This is where you take out a loan against whatever equity you have built up. This can be a very risky option, because they consider your home as your collateral. This means that you could lose your house if for some reason you weren’t able to make the payments back on this loan. Again, you are not wanting to cause yet another problem, so take caution when even considering this as an option.
Borrowing Against Your 401k:
As you’re probably already aware, you can borrow against whatever you have built up in your 401k. It’s like getting a loan from yourself instead of a bank. Another potentially risky option, with this if you are unable to pay this back you could end up losing your retirement funds! Also, make sure you find out all of the details about borrowing from your 401k before you go forward! Get information about what will happen if you lose or quit your job (many times you’ll have to pay that money back in a very short amount of time), how much interest you could be losing out on by pulling that money out, etc).
Debt Consolidation Companies:
This is probably the most common Consolidation option, and the one that typically comes to mind when someone is talking about “Debt Consolidation.” As with the other methods of consolidating debt, there are several potential benefits & risks associated with working with a Debt Consolidation Company. The benefits are the obvious: easier to manage (1 monthly payment instead of several), easier to qualify for this than for some of the other methods, & they do all the work & negotiation for you. But still beware, you want to make sure you know all of the details before deciding to go this route. You may not be able to get a smaller interest rate than you’re currently paying (by the time you feel you need help, you’re probably in a situation where you’re considered a high-risk borrower, which won’t allow you to qualify for a low interest rate). And understand that there are a lot of scams out there! So research, research, research before deciding on one company. Here is some useful information from the FTC to keep in mind when choosing a company to work with.
Pros & Cons
A lot of the same benefits and risks are associated with even the best Debt Consolidation options:
Potential Benefits:
- If you can get a lower interest rate that can save you a lot of money.
- One monthly payment can be a lot easier to manage than numerous payments.
Potential Risks:
- You don’t always end up with a smaller monthly payment.
- Many people can’t qualify for some of the less expensive/lower interest rate methods (bank loan, etc).
- You could be risking a lot more that it’s worth (your home, your retirement) to get out of debt.
- It could take longer (even a lot longer) to pay off your debt.
Other Options:
Here are some other options to consider if you find yourself with unmanageable debt:
