Debt Consolidation: A Step-By-Step Guide
According to the latest data from the Federal Reserve, total consumer debt in the US reached $3.6 trillion in 2016. This comes out to roughly $11,140 in unsecured debt for every single American. These unsecured debts include credit cards, personal loans, medical bills, student loans, and many more.
And despite an improving economy, every year this total continues to increase.
This ever-growing amount of unsecured debt has lead many borrowers to look for ways to simplify their multiple monthly payments and create a plan to finally get these debts paid off.
One solution to finally getting your debts under control is to take advantage of debt consolidation. In this article, we will discuss exactly what debt consolidation is, how it can benefit you, and how to complete the process if you think you would be a good candidate.
Let’s start with some basic information about debt consolidation and how it works.
What is debt consolidation?
Debt consolidation is the process of combining multiple unsecured debts into a single new loan with a single monthly payment. You are basically taking out one new loan that will pay off your multiple smaller loans.
Who is a good candidate for debt consolidation?
Debt consolidation is typically utilized by those with high amounts of consumer debt spread out over multiple loans (credit cards, student loans, personal loans, medical bills, collection accounts, etc).
What types of unsecured debts are eligible for debt consolidation?
The following types of unsecured debts are currently eligible for consolidation:
- Student loans
- Credit card bills
- Store cards
- Personal loans
- Medical bills
- Collection accounts
- Payday loans
What are the benefits of debt consolidation?
- Simplify your payments – Instead of making multiple payments to multiple creditors, debt consolidation allows you to make one simple payment every month.
- A defined timeline to pay off your debts – Most consolidation programs are designed to help you pay off unsecured debts completely in 2 to 5 years. (Student loan consolidation is the exception and typically takes longer.)
- A potentially lower payment and interest rate – Debt consolidation MAY offer you a lower payment and interest rate but it is usually at the expense of a longer payment term, often resulting in you not actually saving on interest at all.
- Save money on fines and late fees – By consolidating your multiple loans into one new loan, you will only have one monthly payment to make which can significantly lower your potential for making late payments and accruing additional fees going forward.
- May improve your credit history – Debt consolidation can gradually help you improve your credit history by allowing you to start building a track record of making your monthly payments in full and on time. You can learn more about additional ways to repair your credit here.
- Potentially end collection calls – Certain debt consolidation options can be an excellent way to finally get your creditors to stop calling you about missed or late payments!
What are the drawbacks of debt consolidation?
While consolidating your debts can have numerous benefits, there are also some drawbacks to be aware of before you start:
- Minimum debt amounts may be required for some companies – Smaller debt amounts may be ineligible for debt consolidation by some companies (however, there are often other options available in these circumstances).
- The debt consolidation process is NOT always quick – Debt consolidation is a process, not a quick fix. It often requires meeting with a credit counselor, setting up a strict budget, and making timely payments over a period of several years.
- You may pay more in interest over the long-term – If your debt consolidation plan involves extending the term with your new loan, you may end up paying more in interest payments over that time period.
- Potential damage to your credit score – Certain debt consolidation options have the disadvantage of lowering your credit score as a result.
What are my debt consolidation options?
If you decide that debt consolidation might be the right choice for you, there are three main avenues you might consider:
- Debt Management Plans (DMPs) – Debt management plans are often the preferred choice of those seeking debt consolidation as they can offer consumers the most advantages.
These plans involve working with a certified credit counselor who will look at your entire financial situation and what monthly payment you could afford based on your income and expenses. These counseling services are typically free and should be utilized by anyone seeking to enroll in a DMP program.
Most DMPs are done through non-profit agencies that have established relationships with most large financial institutions. This allows them to negotiate with your creditors on your behalf to not only simplify your payments going forward but to save you substantially on interest and fees in the process.
Upon enrolling in a DMP, you will then make one payment to your credit counseling agency each month who will then pay your creditors based on the negotiated terms of your new consolidated loan.
DMPs allows you to make just one affordable payment each month and have your entire new loan paid off in 2 to 5 years. These programs are also the best option for improving your credit score.
- Debt Settlement – Debt settlement is an option often recommended for those who simply cannot afford the monthly payments required for a DMP.
Where DMP programs require you to repay your debts in full with more favorable payment options, debt settlement programs involve working with your creditors to actually lower the total amount you have to repay. This negotiated amount can be up to 50% of the original amount owed and is typically required to be repaid within 3 to 5 years.
Your monthly payments are usually lower with a debt settlement program but you will likely also deal with increased collection calls and a negative effect on your credit report as a result.
- Debt Consolidation Loans – Debt consolidation loans involve taking out a new loan from a new lender that is used to pay off all of your smaller loans.
There are several different types of consolidation loans, including
- 0% Interest Balance Transfer Credit Cards – This can be a great option if you only have a few thousand dollars in credit card debt. You can simply open up a new credit card offering 0% interest and then transfer your current balances to this new card. You can also learn more about lowering your credit card payments here.
- Personal Loans – These are a type of consolidation loan that allows you to combine multiple unsecured loans into a single new loan, often at a lower interest rate. These unsecured loans are often made by private companies and can vary widely based on your credit score.
- Home-Equity Loans – Often referred to as “equity loans,” “home equity installment loans,” or “second mortgages,” these loans can be a way of consolidating multiple unsecured debts by borrowing against the current equity value of your home. Borrowers can take out a home-equity loan and use the funds to pay off existing debts leaving them with only one monthly payment going forward. However, these loans often require you to pledge your home as collateral, so your loans are no longer unsecured. Click here to learn more about home-equity loans.
- Student Loan Consolidation – This can be a great option for those with multiple student loans who want the simplicity of one monthly payment, possibly even lower than their previous amount. You can learn more about loan consolidation here.
Consolidation loans can be a quicker solution than a DMP or debt settlement program but may involve higher interest rates and fees.
Some lenders may also require you to pledge additional collateral on the loan, so it is critical to do your research before you make a final decision.
Below are some additional questions that we frequently receive from readers regarding debt consolidation:
How do I know which consolidation option is the best fit?
If you are unsure about which option is right for you, start by talking with a free credit counselor about a debt management program (DMP) as these often have the most benefits for borrowers. If a DMP is not the right fit, ask your counselor for a recommendation.
Will debt consolidation damage my credit score?
That depends on which option you choose. Debt management programs are a great option for improving your credit in the future while debt settlement and debt consolidation loans typically harm your credit in the beginning.
What if I just want to consolidate a smaller amount of credit card debt?
One solution for smaller credit card debts is to simply take out a new 0% interest credit card and transfer your current balances. You can also learn more about lowering your credit card payments here.
If you’re looking for companies that specialize in debt consolidation, below are three very reputable companies that may be able to help you:
Consolidated Credit – (Debt Management Programs) – Consolidated Credit has been a trusted source of credit counseling and debt management solutions for over 20 years and has successfully helped more than 5 million people with their debt solutions. They are an ANAB Accredited company, an EIFLE Award winner for excellence in financial literacy education, and have an A+ rating with the BBB. You can contact them at 1-800-320-9929.
National Debt Relief (Debt Settlement Programs) – Recognized as one of the nation’s top debt settlement companies, National Debt Relief is BBB Accredited and has helped over 100,000 customers get out of debt successfully. You can contact them at 1-888-979-9776.
Lending Club (Debt Consolidation Loans) – As the nation’s largest Peer-To-Peer lender, Lending Club offers personal consolidation loans anywhere from $1,000 up to $40,000. While having stricter credit requirements, their rates are very competitive, and their website is extremely transparent. The company is A+ rated and BBB Accredited.