Alternatives to debt consolidation loans

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Debt consolidation loans are personal loans used to merge high-interest debts such as credit cards, payday loans or other bills into a brand-new fixed-rate loan. After you receive the funds from this loan, they are used to pay off your other debts. If you pay back the loan on time, secure a lower interest rate and don’t take on any additional debt you can’t handle, you may be able to pay off your debt faster and save a ton of money on interest.

However, although using these loans is a good way to consolidate payments and hopefully lower the interest rate on your debt, there are several debt consolidation loan alternatives for people who may not qualify for a debt consolidation loan or those looking for rock-bottom interest rates.

Debt consolidation loan alternatives

A debt consolidation loan is not right for everyone. Because debt consolidation loans are unsecured personal loans, lenders may have tighter eligibility requirements, or the loans may not be large enough for the types of debt you’re trying to consolidate. A few debt consolidation loan alternatives include:

  1. Balance transfer credit card: A balance transfer card allows you to transfer debt from other credit cards — usually credit cards from other companies only — or use a balance transfer check to combine other forms of debt at a 0 percent interest rate. This low promotional rate period typically lasts from 12 to 21 months, and a good to excellent credit score is needed for approval. Once the introductory period ends, you’ll be responsible for paying the card’s standard interest rate on the remaining balance. Additionally, most cards will charge you a balance transfer fee on the total amount you transfer, typically from 2 to 5 percent.
  2. Home equity loan or HELOC: Home equity loans and home equity lines of credit (HELOCs) allow you to borrow against the equity in your home. While a home equity loan has fixed monthly payments at a fixed interest rate, a HELOC works like a credit card and has a variable interest rate. Both can be used to consolidate high-interest debt, but you’ll risk losing your home if you can’t pay them back. Also, both require that you have a certain amount of equity in your home. By comparison with debt consolidation loans, home equity loans and HELOCs often have longer repayment periods, larger loan amounts and lower interest rates.
  3. Cash-out refinance: A cash-out refinance replaces your existing mortgage with a brand-new one that’s larger than your current outstanding balance. You can withdraw the difference between the two balances and use it to improve your home or consolidate debt. As with using a home equity loan or HELOC, you’ll risk losing your home if you can’t repay your new loan.
  4. Debt settlement: Debt settlement takes place when you negotiate with your lender to pay a lower amount than what’s owed to satisfy the debt. You can negotiate with the debtor yourself or pay a fee to a debt settlement company or lawyer to negotiate on your behalf. Even if you, a lawyer or a company successfully negotiates a settlement, your credit score may take a hit.
  5. Bankruptcy: Filing for bankruptcy involves going to a federal court to get your debts discharged or reorganizing them to give you time to pay them off. Although you can discharge your medical debt, personal loans and credit card debt in bankruptcy, it’s incredibly difficult to discharge student loans and tax debt. Before you choose this alternative, keep in mind that your credit score will suffer a major blow; it may take years for it to recover.

The bottom line

While using a debt consolidation loan to merge your high-interest debt can make sense financially if you can secure a lower interest rate, it’s not your only option. In some cases, choosing an alternative route can be a better choice. For example, you might be able to secure a lower rate by taking out a home equity loan, since it’s a secured loan backed by your home.

However, it’s also important to know the risks of choosing such an alternative. Shop around with different options and compare the interest rates, repayment terms and trade-offs you’ll make with each one before proceeding.

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