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Overwhelmed by Bills? Debt Consolidation May Offer a Solution

If the number of bills you receive every month is overwhelming, debt consolidation may be a good option for you.

Debt consolidation is a process you can initiate yourself to pay off two or more debts. It involves combining them into one new loan or using another loan to pay off several, existing debts. This allows you to better manage your debt by making one payment to a single lender rather than juggling several debts with multiple creditors. Most types of debt can be consolidated including student loans, personal loans, mortgages, credit cards and vehicle loans.

Types of Debt Consolidation

If you decide debt consolidation is right for you, the next step is choosing the best type of consolidation to pursue. There are several options for debt consolidation:

  • Personal or debt consolidation loan
    Many banks, credit unions and online lenders offer some form of personal or debt consolidation loan. Interest rates vary but are fixed at lower rates than credit cards. Such loans can include origination fees, as well as pre-payment penalties. Others require collateral like a house or vehicle. If your credit score is low, it can be difficult to qualify for a personal loan or obtain an attractive interest rate.
  • Balance transfer credit card
    These cards allow you to transfer a balance from another card at a temporary 0% interest rate, which normally lasts from 12 to 18 months. They often charge balance transfer fees ranging from 2%-3% of the transferred balance.
  • Debt Management Plan
    Debt management plans give you the benefits of debt consolidation without the need to qualify for additional credit. Plus, a DMP can help you reduce the length of time it takes to repay credit card debt and lower the total amount of interest you pay. Most participants pay off their debts within five years. A debt management plan may be a recommended option to eliminate your debt after going through a free credit counseling session.
  • 401(k) loan
    With a 401(k) loan, you borrow money from your workplace retirement account to pay off other debts. Rules for such loans vary by employer, but generally you could borrow as much as 50% of your balance, up to a maximum of $50,000, within a 12-month period. 401(k) loans must be repaid, with interest, within five years, depending on your plan’s rules. The interest you pay goes to your retirement account. If you default on a 401(k) loan, it won’t affect your credit because such loans aren’t reported to credit bureaus. But if you default, you’ll owe both taxes and a 10% early withdrawal penalty if you’re under 59½.
  • Home equity loan
    A home equity loan, sometimes called a second mortgage, allows you to borrow a lump sum based on a percentage of the value of your home’s equity. You make monthly payments of principal and interest for the life of the loan. Interest rates are often much lower than credit cards, but your house becomes collateral, which means you could lose your home if you don’t keep up with payments.
  • Home equity line of credit
    Similar to a home equity loan, a home equity line of credit, or HELOC, allows you to tap into your home’s equity as a way to consolidate debt. While it resembles a home equity loan, a HELOC functions more like a credit card with a limit determined by your home equity, income and credit score. HELOCs use your house as collateral, meaning you could lose your home if you’re unable to repay. HELOCs come with a number of costs similar to a mortgage including application fees, origination fees and appraisal fees.
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Pros of Debt Consolidation

No matter what form of debt consolidation you pursue, there are several benefits:

  • Fewer bills to pay:
    Debt consolidation allows you to make one payment to one lender every month rather than multiple payments to different lenders with various due dates.
  • Saving on interest:
    With debt consolidation, you’ll likely be paying a lower interest rate on the combined debt.
  • Pay off debt faster:
    With a lower interest rate, more of your payment will apply toward the balance, which can contribute to a quicker paydown of your debt.
  • Improved credit score:
    Consolidating your debts will pay off all the cards and loans included in the combined loan. As a result, you may see a boost to your credit score, so long as you don’t use your credit cards for fresh spending.
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Cons of Debt Consolidation

Risks of debt consolidation vary depending on the approach and form you take with your consolidation.

  • You still owe the debt:
    Debt consolidation may make managing your debt a lot easier, but it does not eliminate it completely. You still owe the same amount of money. And if you don’t decrease your spending, you will owe even more and be no closer to being debt free.
  • Good credit is often required:
    To secure interest rates that make consolidation worthwhile, you need to have good credit. If you don’t, your interest rate may be similar to what you’re paying now.
  • Upfront costs may be involved:
    Many debt consolidation options come with fees and costs, whether a balance transfer fee or closing costs.
  • Assets could be at risk:
    If you consolidate unsecured debt into a secured loan, you will need to put up collateral (like your home or car) to acquire immediate cash. Your assets could be at risk if you fail to repay the loan.

Debt Consolidation vs. Debt Settlement

While they may sound similar, debt consolidation and debt settlement are vastly different debt relief strategies. Whereas debt consolidation offers a way to combine multiple debts into one payment to provide a streamlined way to repay, debt settlement is a service offered by for-profit companies that allows consumers to pay back only a portion of the debt they owe using some questionable tactics that may have serious negative consequences.

Here’s a simple breakdown of how debt settlement works:

  • People who choose debt settlement make regular deposits into a dedicated bank account until there is enough for the debt settlement company to negotiate lump-sum payments.
  • During this process, the debt settlement company may advise clients to stop making payments to their creditors as a tactic to get the creditor to accept a lesser amount to settle the debt.
  • Once creditors accept the lump-sum settlement payments, accounts are considered paid-in-full.

There are serious drawbacks to this process that are important to understand before signing up. Failure to pay your creditors, even at the advice of a debt settlement company, can have serious negative consequences, such as:

  • High fees you pay to the debt settlement company to “settle” the debt
  • Tax implications related to any forgiven debt, potentially resulting in a large and unexpected tax bill
  • Late fees charged by your creditors when you stop making payments
  • A significant drop in credit rating, affecting your ability to qualify for a mortgage or rental property, auto loan, or even get hired for a job in some cases

Debt management is yet another similar sounding term with a very different outcome. Debt management plans are offered by nonprofit agencies like Take Charge America. The program is designed to reduce the length of time it takes to repay credit card debt and lowers the total amount of interest paid. Participants receive ongoing education to develop effective spending habits, budget to meet living expenses, manage debt and save for the future.

Assessing Next Steps in Debt Relief

If you’re unsure where to turn, start with a free and confidential credit counseling session. We will review your income, expenses and debts to determine the best course of action.

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You can also call us Monday – Friday from 6 a.m. – 6 p.m. MST at 866-528-0588 to speak with a certified credit counselor.

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