The Complete Guide To Debt Consolidation

Even though the economy is improving, millions of Americans are still in debt.

This can have a negative impact on their credit score making it difficult for them to secure any type of financing.

One way people are looking to repair their bad credit rating and raise their score is to consolidate their debt. It is one viable option to consider if you are looking for a way to start paying off your accumulated debt.

What is Debt Consolidation?

Debt consolidation is when you combine several unsecured loans into a single monthly bill. Some examples of unsecured debt include,

Medical bills
Credit cards
Personal loans (i.e. school)
Payday advances/loans

One of the main advantages in combining your debt is that it can reduce your chances of forgetting a payment. Instead of keeping track of several monthly bill due dates, now there is only one. Missed and late payments on loans is one of the leading causes for poor credit scores.

There are three types of debt consolidation consumers generally consider.

Debt Management Plans
Debt Consolidation Loans
Debt Settlement Agreements

It is important to remember that debt consolidation is not an instant fix.

You will not see an immediate improvement in your credit score. However, after you’ve made several payments on time it can be an effective first step in repairing your bad credit score.

Some of the other benefits that often come with consolidating unsecured debt can include,

Lower interest rates
Repair poor credit scores
Lower monthly loan payments
Reduce the amount of time you’re in debt

Debt Management Plans vs Debt Consolidation Loans

When you are trying to decide what is the best way to consolidate debt, you’ll want to figure out how much you owe. If you owe less than $3000 in credit card debt, your best credit repair option might be to apply for a new charge account with a lower or no interest rate.

Simply transferring the balance can dramatically reduce monthly payments, along with the amount of time you’re in debt.

You can also borrow against your retirement savings or life insurance plan if your overall debt is less than $3000. If you owe more than $3000 in credit card debt, your best course of action might be a debt management plan.

Debt Management Plan

Debt management plans (DMP) are often recommended by financial experts. The most effective ones are usually managed by a non-profit organization, and start with a credit counseling session.

Once your monthly payment amount has been decided the credit counseling will work with your creditors to,

Lower interest rates
Remove or reduce late/missed payment fees

In some cases, a credit counselor can even reduce the total amount of the debt.

Each month you send one payment to the credit counseling agency monitoring your debt management plan. They will divide the amount among your creditors, eliminating all the harassing phone calls and collection letters.

The downside to a debt management plan is that it can temporarily lower your credit score. Once the debt has been repaid, typically in 3 to 5 years, you should see an almost immediate improvement in your credit score.

Debt Consolidation Loans

If you don’t want your credit score to drop any lower, you might want to consider a debt consolidation loan (DCL).

The main drawback is that this method won’t shorten the length of repayment time, but it will let you make one monthly payment.

Instead of sending several smaller payments to different creditors, you will simply make a single larger one. A debt consolidation loan will also come with a lower interest rate. Some of the types of DCLs you might want to consider can include,

Personal loans
Home equity loans
Balance transferred to zero or low interest credit cards
Student loan consolidation

Understanding Bill Consolidation

Bill consolidation is simply combining your bills and using a loan to pay them off. This way your credit report will reflect the positive settlement of several debts, along with your ability to effectively manage the new loan payments.

This is an extremely effective way to boost your credit score, though you will have to go through the loan approval process.

If your credit score is already below subpar, this might not be the best option for consolidating your debt.

Tips on Getting a Consolidation Loan

The first step is to add the total of the bills you are trying to consolidate. This includes the amount of the monthly payments, along with the interest rates. You will also want to know your current credit score before you start looking for a consolidation loan.

Some of the best places to apply for a debt consolidation loan will include,

Banks
Credit Unions
Online lending companies

Many financial experts recommend starting with an online lender. Your chances of being approved for a loan are increased, and many offer lower interest rates. Before you accept any consolidation loan offer you will want to compare the following among the various lenders.

Interest rates
Any fees or penalties for early loan repayment
Length of the loan

When you are taking out a consolidation loan it should not only shorten the amount of time you are in debt, but also lower your monthly payments and interest rates. If it doesn’t accomplish all three, you will want to keep looking at the various lenders.

Consolidating Credit Card Debt

If your credit score is above 700, financial experts typically recommend applying for a zero-interest account.

Your “good” FICO score should allow you to qualify for a no-interest credit card, and you can use this to pay off your higher interest debt.

While this can be an effective way to eliminate your credit card debt yourself, there are a few drawbacks you’ll want to consider.

The introductory no interest rate typically only lasts 6 to 18 months. During this period 100 percent of your monthly payments will be applied towards your balance.
Interest rates on the remaining balance can jump as high as 27 percent, though they typically remain around 13 percent.
A “balance” transfer fee can be applied.
Some credit cards come with annual “maintenance” fees.

You can avoid many of these downfalls simply by “shopping around” for the best credit card offer.

How to Consolidate Bills

You will need to be patient and organized when you are consolidating your bills. In some cases, you might also have to be persistent when you are trying to figure out the total amount of your debt.

After you have the total amount of debt owed, it is time to decide how much you can afford to pay each month.

Once you have settled on these numbers, it will be easier to decide whether a debt management plan, debt settlement or personal loan is the right financial choice for you.

Regardless of the type of debt consolidation method you choose, it is always important to remember that it will not be an instant fix for your poor credit score.

When NOT to Consolidate Debt

Even though consolidating your debt does come with several advantages, it is not always the right choice for everyone. There are times when it could increase your debt, and have a detrimental effect on your credit score.

If the debt is transferred to a zero-balance credit card, but you don’t change your spending habits you can easily find the total amount you owe steadily increasing.
Debt consolidation can cause your credit score to drop making it difficult for you to secure a home or even high interest auto loan. If you are planning on applying for one of these loans, you might want to wait to consolidate your debt.
If you use your home or vehicle as collateral for a debt consolidation, you could be at risk for repossession or foreclosure if the monthly loan payments aren’t made in full.

Taking the time to get all your paperwork in order and knowing exactly what you can afford to pay each month are the first steps in ensuring that a debt consolidation loan is the right choice for your financial situation.

If you need advice on how to change your spending habits, you will want to speak to a qualified debt counselor.

Consolidate Debt in 3 Simple Steps

If you’ve decided that debt consolidation is the best way to repair a poor credit score, there are three simple steps you need to follow.

Take the first step.

The first step is to decide to start paying off your debts, and repairing your bad credit. The sooner you start working on a strategy to repay your debt, the quicker it will go away. This also means seeing a faster improvement in your credit score.

Know what your options are.

If you don’t know what your options are, it will be impossible for you to make the right decision for your situation. A debt management plan should be your first option, unless you have a “good” credit rating or owe less than $3000. In these cases, a personal loan or transferring the balances might work best for you.

It is also important that you know which type of debt can be consolidated. For example, you cannot consolidate federal student loans with the rest of your debt.

Be aware of the risks.

Financial advisors might not always fully inform you of all the risks associated with debt consolidation. The first one being, that it is not always the best choice for everyone. Using a home or automobile as collateral is risky, along with putting up retirement savings.

Before you choose any debt consolidation option, you should be well-aware of any potential risks.

Simply following these 3 steps will help prevent you from making a potential mistake that could end up hurting your credit score. Before you make any final decisions, it is always best to speak with a qualified financial advisor.