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Is Debt Consolidation the Best Way to Fix My Finances?

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Claire Matthews

Financial Advisor, DCL

Is Debt Consolidation the Best Way to Fix My Finances?

If you are drowning in your debt and struggling just to make the minimum monthly payments on your credit cards, then you may be considering managing your debt by applying for a debt consolidation loan. If you are close to maxing out your credit lines or have already exceeded your maximum credit limit, then a debt consolidation loan may be a good option for you to consider.

What is Debt Consolidation?

Debt consolidation may be done in a few different ways, and they all have their advantages and disadvantages, so you will have to analyze your finances and determine which is the best option for your situation. Debt consolidation allows you to combine your unsecured debts into one bill or account so you only have one monthly payment.  In most cases, you receive a loan to pay off your debts, and then you make monthly payments to the lender.

Debts that may be included in a consolidation loan are credit cards, medical bills or personal loans. A debt consolidation loan is only beneficial if you have a lower interest rate than what you are currently being charged. Most debt consolidation options come with fees or other charges, so it is important to understand the details of any plan before you make a final decision.

Making Permanent Changes

If you are considering a debt consolidation loan, or any other debt management or reduction option, you need to be honest with yourself. You didn’t just wake up one day with multiple credit cards or high balances, so you need to address the root cause of the problem. Take a fresh look at your expenses and your past spending habits, and see where you went wrong. There is nothing to be ashamed of, millions of Americans find themselves overwhelmed in debt, but you have to be committed to changing your way of life if you want to have financial freedom.

In many cases, unemployment or excessive medical bills can lead to excessive debt, so this is not to say you are irresponsible, but you will have to make changes to avoid falling back into debt. Not only will you need to avoid opening new credit card accounts, but you also need to develop a savings or emergency fund plan so you don’t have to rely on them in an emergency.

A debt consolidation loan, or any other debt reduction plan, will not work if you continue to accumulate credit card debt or spend more than you earn. To be successful in overcoming your debt, you will have to reduce your spending so you can live off your income without any assistance.

Talk to a Credit Counselor

There are many non-profit organizations who offer credit counseling services, so you may want to seek help from a professional who has experience with the best debt consolidation and debt reduction or management plans. Credit counselors can help you determine the best path to take toward eliminating your debt. They will look over your finances with you and show you how you can make changes so you can put more money toward paying off your debt.

Debt Consolidation Loans

A Discover debt consolidation loan is definitely an option to consider if you are looking to reduce or eliminate your debt. If you can get the best debt consolidation loan rates, reasonable monthly payments and a relatively short loan term, then a debt consolidation loan is a good idea.

A debt consolidation loan is similar to a traditional loan, except the money is used to pay off your debts. There are many online lenders who offer this type of loan, so be sure to use a legitimate service. Each lender will have varying loan amounts, with interest rates between 5% and 36%. Typically, the lower your credit score, the higher your interest rate will be, because the lender is assuming a greater risk. In most cases, you will also be charged a loan fee that is a certain percentage of the loan amount, usually between 1% and 5%.

A debt consolidation loan can be a good idea if it is used responsibly and if you are ready to reduce your expenses in order to live a life free of credit cards and overspending. If you get a debt consolidation loan, you should be prepared to cut up all your credit cards and to only use the money in your bank account for expenses. Eventually, you may decide to use a credit card, but you should only do so if you can use it responsibly.

Debt Management Plans

A debt management or debt settlement plan will involve a credit counseling organization or debt settlement company who negotiates on your behalf to reduce the amount you owe to each creditor. They will also work to reduce your interest rate and extend the payment term.  Of course, you will have to pay the organization a fee for their services. You may also have to pay taxes on any amount your debt is reduced, because it is considered income to the IRS.

A debt settlement can be a long, drawn-out process that can take months to years to complete.

The debt settlement company or credit counselor will ask the lender if they are willing to settle, and at what amount. It is important to note that if your account has already been turned over to collections because of non-payment, then your chances of getting a settlement are greatly reduced.

In some cases, you will have to make monthly payments to the company or organization, and they will accumulate that money and use it to pay off your debts one by one. The debt management company will typically request that you stop paying on your accounts, so you will continue to accrue interest and late fees, and your credit score will be severely damaged.

Use a Reputable Lender

If you choose to pursue a debt consolidation loan or use a credit counseling organization, be sure to use a legitimate lender. Unfortunately, there are many scam artists posing as lenders, and if you fall into their trap, you won’t be overcoming your debt.  Instead, you will be damaging your financial situation significantly and in most cases, you will wind up with more debt than when you began.

Some lenders you may want to consider are Lending Club, PersonalLoans.com or other similar lenders who have BBB ratings and have a good reputation. Some credit card companies including Discover and Capital One offer debt consolidation services, so you may choose to go that route because they are well-known credit organizations.

Just because you are using a reputable lender, do not assume you are getting a good deal. You should compare offers from a few lenders to see who is offering the best deal in terms of loan fees, interest rates, and the loan period. It is up to you to make a responsible choice when selecting a lender for a debt consolidation loan, or an organization who offers credit counseling or debt settlement services.

Balance Transfers

A balance transfer is another way to consolidate your debt, but it also comes with fees and stipulations that can end up costing you more money in the long run. With a balance transfer, you will combine all your credit card debt into one credit line and have just one monthly payment as opposed to paying each creditor individually each month. Many credit card companies offer a 0% introductory rate on all balance transfers, so it sounds appealing.

The disadvantages of a balance transfer include paying a fee on the amount you transfer, usually a certain percentage of the total amount. After the introductory period expires, the annual percentage rate (APR) may rise up to or above 20%, so it is important to read the fine print to understand the details of the balance transfer. If you make one late payment, the interest rate may increase even more.

Home Equity Loan

If you own your home, you may consider consolidating your debt through a home equity loan. A home equity loan allows you to use your house as collateral for a loan, and is sometimes referred to as a second mortgage. Typically, you will get a lower interest rate on a home equity loan, because the lender has your house as security if you default on the loan. Yes, if you default on a home equity loan, the bank can repossess your house and sell it to get their money back. Even if you have bad credit, you may still be able to get a reasonable interest rate on a home equity loan.

A home equity loan is typically available in either a lump-sum payment or a line of credit. A lump-sum payment is when you receive all them money up front once the loan is approved. You will then have to repay the loan in monthly installments, including interest rates and loan fees. With a line of credit, you will get approved for a line up to a certain amount, so you may only use the amount you need.  You will only be charged interest on the money you use, so it can eliminate paying additional interest charges.

Reduce Debt on Your Own

If you make some sacrifices, you can cut down on your expenses and put the extra money toward reducing your debt. You may have to downsize your lifestyle or cut back on amusement or entertainment activities, but eventually you will be debt-free, so the sacrifice does pay off. Using a credit card payoff calculator can help you make a better plan. If you make changes to manage your finances responsibly, you can still do the things you enjoy in moderation.

If you have extremely high debt or you are already facing collection agency calls, it may be more difficult to reduce your debt on your own, but it is possible. You can contact your creditors or speak to the collections agencies and negotiate terms you can afford.  In some cases, you may be able to reduce the amount you owe or reduce the interest rate you are being charged.

Is a Debt Consolidation Loan the Best Decision for Me?

Only you can answer whether debt consolidation vs bankruptcy is right for you, because it depends on your specific financial situation. Consulting with a credit counselor can help you analyze your finances and determine what the best option is for you to reduce or eliminate your debt. Do not rush into a debt consolidation loan or any other service where fees are involved. Take your time and compare your options so you can make a rational decision that will result in financial freedom.

If your finances are severely damaged, you may also consider bankruptcy to eliminate your debts; however, this should only be used as a last resort, and there are qualifications you must meet to be eligible to file for bankruptcy. In most cases, your debt will have to extremely outweigh your income. Regardless of your decision, it is important to understand all the details of whichever avenue you choose to pursue.  Once you sign for a loan or a settlement, there is no going back.

If you can find a debt consolidation loan with a relatively low interest rate that is lower than what you are currently being charged and you can afford the monthly payments, then a debt consolidation loan may be the best choice for you. If you’re former military you may qualify for military debt consolidation or a debt consolidation loan for veterans. Keep in mind that you must be dedicated to reducing your debt and you will have to make lifestyle changes to avoid falling back into debt you cannot get out of.  If at all possible, try to reduce your debt on your own. You will be saving money in the long run, and you will have the satisfaction of living debt-free without any assistance.

Defaulting on a debt consolidation loan will severely damage your financial situation, so you should only use this loan if you are certain you can afford the payments. If you default on a home equity loan, you can lose your home. Debt consolidation loans can be useful, but they can also have damaging consequences.

 

Claire Matthews

Claire Matthews

Financial Advisor, DCL

Claire is a noted financial writer and author of hundreds of articles about personal and business finance. Before getting her MBA, she graduated with a BS in Economics. Her coursework focused on the different ways that debt, debt structure, and debt restructuring affect micro and macro-economic issues.

Upon graduation, she took a job at an investment bank that worked with municipal and county governments to help them reorganize and structure their debt so they could continue to provide essential city services.

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