Getting out of debt is challenging, especially when you have multiple creditors. If you are juggling different accounts, payment amounts and due dates, you may be considering debt consolidation.
Debt consolidation involves rolling many debts into a single payment, and there are several ways to implement this strategy. Furthermore, it can save you money in interest, help you pay off debts faster, simplify your finances and give you peace of mind.
1. Balance transfer credit card
The best balance transfer cards often come with zero interest or a very low interest rate for an introductory period of up to 18 months. If you get a balance transfer card, you’ll move the balances from high-interest rate credit cards to the new one. The idea is to pay the entire balance before the promotional APR period ends or you risk racking up even more interest than you started with.
You’ll need a balance transfer card with a credit limit that is high enough to accommodate the balances you’re rolling over and an annual percentage rate (APR) low enough to make it worthwhile. Use a credit card balance transfer calculator to see how long it will take you to pay off your balances.
Using a balance transfer credit card is best for those who are disciplined and will avoid running up debt on their existing credit cards once the balances have been shifted to the new card. If you choose to use a balance transfer credit card, have a plan to pay off the debt before the credit card’s introductory rate expires.
2. Home equity loan or home equity line of credit (HELOC)
Home equity is the difference between the appraised value of your home and how much you owe on your mortgage. If you’re a homeowner with enough equity and a good credit history, you can borrow some of that equity at an affordable rate to consolidate your debts. Many home equity borrowers use the money to pay off higher-interest debt, such as credit cards.
Your options for borrowing from home equity include home equity loans, which give you a lump sum of money at a fixed rate, and HELOCs, which give you a credit line to draw from at a variable rate. Both act as second mortgages, which means you’ll add an additional monthly payment to your plate. Still, they can be good options for debt consolidation if you have enough equity to qualify.
HELOCs are often best for those who have significant equity in their home and prefer a long repayment timeline. Before opening a HELOC, shop for the most competitive interest rate. It’s also important to be disciplined about using a HELOC and repayment of the debt.
3. Debt consolidation loan
A debt consolidation loan can be a smart way to consolidate debt if you qualify for a low interest rate, enough funds to cover your debts and a comfortable repayment term. These loans are unsecured, so your rate and borrowing limit hinge on your credit profile.
You’ll use all or a portion of the loan proceeds to pay off the balances for debts you want to consolidate. And instead of paying each creditor monthly, you’ll now make a single monthly payment on the personal loan to streamline the debt payoff process.
Debt consolidation loans are generally a good option for those who have a credit profile that allows for securing favorable interest rates and a borrowing limit that accommodates all of your debt. You’ll generally need a credit score at least in the mid-600s and a history of making on-time payments for the best rates, although bad credit personal loans exist.
4. Peer-to-peer loan
Peer-to-peer lending platforms pair borrowers and individual investors for unsecured loans that generally range from $25,000 to $50,000. Like personal loans, P2P loans are unsecured, so the borrower’s credit history is the key factor for rates, terms, borrowing limits and fees. The higher your credit score, the lower the interest rate and the more you can borrow.
Eligibility requirements for peer-to-peer lending are not always as strict as other types of borrowing. Some P2P lenders allow applicants to qualify with a lower credit score. Before using this type of loan, compare the fees and interest rates with other options.
P2P loans are most ideal for borrowers seeking loans with less stringent eligibility criteria and rapid funding timelines. They could also be a good fit if you have a lower credit score or limited credit history.
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 — especially as an alternative to bankruptcy.
With a debt management plan, you work with a nonprofit credit counseling agency or a debt relief company 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. You still receive all billing statements from your creditors, so it’s easy to track how fast your debt is being paid off.
Debt management plans are typically a good choice for those who are deep in debt and need help structuring repayment. But you will need to find out whether your debt qualifies for this type of plan.
How to avoid falling into debt
Consumers who have borrowed and spent so much that they must borrow more to consolidate debt need to take a hard look at their spending habits. “You need to identify where the debt came from,” says Celeste Collins, executive director of OnTrack WNC Financial Education & Counseling in North Carolina. “How did this balance get there? You need a comprehensive cash flow plan and to get serious about paying this down.”
Once you’re out of the debt hole, you can avoid that predicament again. Here are some rules to live by:
- Set a budget and stick to it. Live within your means.
- Avoid impulse purchases.
- Shop around for the lowest price before making a big purchase.
- If you use a credit card, pay off the balance each month to avoid interest charges.
- Keep your finances organized and keep a close eye on your bank balances.
- Stay away from “buy now, pay later” and “interest-free financing” offers, which just defer your debt.
- Save money. Try to set aside a certain percentage of your income to be swept into savings.
The bottom line
There’s no shortage of debt consolidation options. When considering which strategies could work for you, analyze each lender’s interest rates, loan terms and fees. If possible, avoid subprime lenders that cater to consumers with bad credit — these lenders offer the highest interest rates and unforgiving loan terms. Even if your credit score is lower, it’s worth shopping around with traditional lenders first.
It’s equally important to confirm the lenders you’re considering are legitimate. Visit their websites, research the lenders to find reviews from past and current customers, check their registration status with the state you live in and contact your state’s attorney general’s office for further verification.
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