Whether you’ve maxed out all your credit cards, are up to your neck in student loans or have a mountain of medical bills, it’s smart to look for the best ways to consolidate your debt.
Debt consolidation — or the strategy of rolling many debts into a single payment — can save you money in interest, help you pay off debts faster, simplify your finances and give you peace of mind.
The best options include balance transfer credit cards, home equity loans or lines of credit, personal loans, peer-to-peer loans and debt management plans.
Learn the pros and cons of each option to find the one that works best for your financial situation.
1. Balance transfer credit cards
Transferring your debts to one credit card could save you money in interest, especially if you’re paying off other, higher-rate credit cards. And you’ll have only one monthly payment.
You’ll need a balance transfer card with a credit limit that is high enough to accommodate all the balances you’re rolling over and an annual percentage rate (APR) low enough to make debt consolidation by credit card worthwhile.
Credit card debt is usually unsecured, so you won’t have to risk any assets, such as your home, as collateral. It’s often quicker and easier to get a balance transfer credit card than it is a bank loan.
Beware of limits and fees
Ask about the interest rate, balance transfer limits and fees before you apply, advises Celeste Collins, executive director of OnTrack WNC Financial Education & Counseling, a nonprofit agency in western North Carolina. You won’t know the APR or credit limit until after you’re approved.
Balance transfer cards tend to have a low introductory rate, often as low as 0 percent, that expires after a certain length of time. Your goal should be to pay off the balance before the introductory rate expires. If you’re transferring $9,000 in debt to a card charging 0 percent for 18 months, for example, try to discipline yourself to make a payment of, say, $500 a month so you pay everything off before your interest rate spikes.
Keep in mind that whether you request a credit-line increase or apply for a new credit card, the issuer will pull your credit history, which can lower your credit score.
Make a plan for the future
Using one card as the repository for all your credit card debt has risk, so be cautious if this is your plan for debt consolidation. Once you’ve transferred debts to a single credit card, focus on paying down that card as quickly as possible. And try not to take on new debt.
“You need to identify where the debt came from,” says Collins. “How did this balance get there? You need a comprehensive cash flow plan and to get serious about paying this down.”
2. Home equity loans
If you’re a homeowner with strong credit and a solid financial history, tapping into your home equity could be a good debt consolidation option for you. (Home equity is the difference between the appraised value of your home and any mortgage loan balance.)
Get lower rates and payments
Home equity loans have lower interest rates than credit cards, and tend to be larger than personal loans or credit card limits, says Bruce McClary, spokesman for the National Foundation for Credit Counseling. The average interest rate on a home equity loan in mid-March 2019 was 5.95 percent, according to Bankrate, versus an average credit card APR of 17.84 percent.
Home equity loans have longer repayment periods, which can mean lower monthly payments but also more interest over the life of the loan, he says.
Weigh the risks first
Home equity loans, however, can be risky as a method of debt consolidation. If you’re offering your house as collateral in order to pay off unsecured credit card debt, you’re trading the burden of card debt for the possibility of losing your home.
“You increase your risk exposure,” says Collins. “What if you lose your job? If you default on a credit card, the lender just charges it off. But if you default on a home equity loan, it gives the lender a chance to foreclose on your home.”
Home equity loans can come with variable interest rates, which means the amount you pay on interest could rise or fall depending on changing market conditions, warns McClary. So today’s affordable payment could be tomorrow’s debt disaster.
“It’s not unusual for a home equity line of credit (HELOC) to have a variable interest rate,” he says. “Rates don’t typically experience extreme adjustments, but if you are living close to the edge with your budget, a small adjustment could be enough to cause problems.”
Also, it often takes longer to get a second mortgage — a few weeks to a few months — due to the lengthy closing process, he adds.
Something else to consider before you use a HELOC to consolidate debt: The new federal tax law eliminates the tax deduction for interest you pay on a home equity loan unless you use the loan to build or improve your property.
3. Personal loans
Also called a “signature loan,” a personal loan is an unsecured loan based on your creditworthiness. Unlike a credit card, a personal loan has fixed, equal monthly payments, says McClary. Loan amounts depend on the borrower’s credit score and credit payment history, but personal loans typically top out at around $10,000, he says, although some banks will offer more sizable loans.
Banks and credit unions offer personal loans, but subprime lenders that lend to borrowers with poor credit scores, also are very active in the personal loans market, McClary warns. So it’s important to shop carefully and understand rates, terms and fees.
“Subprime lenders are widely known for offering the highest interest rates and fees for loans, so it pays to consider other financing options first,” says McClary. “Never assume you can’t qualify for a better rate without checking your credit and shopping around.”
Adds McClary: “Even if you qualify for a loan from a prime lender but aren’t approved for their lowest rate, the difference between that rate and one from a subprime lender could save you thousands of dollars and can make it much easier to make faster progress paying down your balance.”
Because a personal loan is unsecured, there are no assets at risk, making it a good option if you think your bank is the best option for a consolidation loan. However, be aware that a large, prime-rate loan requires good credit. And rates are typically higher for personal loans than they are for home equity loans.
4. Peer-to-peer loans
Traditional lending institutions are not the only option for consumers looking to consolidate debt.
Peer-to-peer lenders such as Upstart, Prosper, Peerform, LendingClub and CircleBack Lending pair borrowers and investors for unsecured loans that range from $25,000 to $50,000, depending on the platform and the borrower’s credit profile.
Good credit still counts
Borrowers with so-so credit might find it easier to get a loan at a P2P network than from a standard financial institution. But as with any loan, your credit score counts and the higher it is, the less interest you’ll pay.
For example, a three-year, $10,000 personal loan through Prosper for a borrower with an AA rating for “excellent credit” has an interest rate of 5.31 percent and a 2.41 percent origination fee, for an APR of 6.95 percent, according to the Prosper website. But the high-risk borrower can expect to pay an APR of up to 35.99 percent.
“Read the fine print and know what you are getting into,” says Collins. “I do think it’s cool that there are alternative ways to borrow money.”
5. Debt management plan
If you want debt consolidation options that don’t require taking out a loan or applying for a balance transfer credit card, a debt management plan could be right for you.
With a debt management plan, you work with a nonprofit credit counseling agency to negotiate with creditors and draft a payoff plan. You close all credit card accounts and make one monthly payment to the agency, which pays the creditors. But you still receive all billing statements from your creditors, so it’s easy to track how fast your debt is being paid off.
Look for lower interest rates
With a debt management plan, you’ll get some of the best debt consolidation loan rates (but not lower balances) and an end to over-limit and late fees, McClary says. Also, agencies may work for a low cost or no cost if you’re struggling.
To create a debt management plan, stick with nonprofit agencies affiliated with the National Foundation for Credit Counseling (NFCC) or the Financial Counseling Association of America, and make sure your debt counselor is certified by Council on Accreditation (COA), Collins advises.
Consider the effect on your credit
While you’re on a debt management plan, you won’t be able to reach for credit cards in a pinch because you’ll have to close all of your accounts. This will lower your credit score. However, if you keep up with your payments and don’t go deeper into debt, a debt management plan can help improve your credit score long-term.
“This is not for people who just want a better interest rate,” Collins says. “It’s a radical step that’s often seen as an alternative to bankruptcy. We help people really shift their relationship to money.”
Know who you’re dealing with
Collins warns against confusing “debt management” with “debt settlement.” “This is a really important distinction to make,” she says.
Debt settlement businesses, which are illegal in some states, offer to settle your debt for pennies on the dollar. They collect money from you over time, put it in trust and when they think there is enough to make your creditors a settlement offer, they negotiate an amount.
“They ask that credit card statements go to them, so the consumer doesn’t even know what is going on,” says Collins.
Getting to the negotiating point can take years. In the meantime, your credit is ruined. And you might have to pay tax on the forgiven debt. For example, if you owed $12,000, but it was negotiated down to $4,000, you could owe tax on $8,000.
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