Debt Consolidation Options

Do you have a lot of debt? You’re not alone. More and more Americans are burdened with credit card and loan payments. As you work toward your financial goals, carrying debt — especially high-interest debt — can slow you down.
 
Whether you want to improve your money management, make ends meet, lower your monthly loan payments or just stay on top of your bills, debt consolidation may help.

What is debt consolidation?

Debt consolidation allows you to combine your smaller individual loans and credit card debt into one larger loan. Instead of making monthly payments to each creditor, you make a single monthly payment, usually at a lower interest rate. So, it streamlines your monthly bills while (typically) lowering the total interest you pay over time. That single payment may also be more affordable, freeing up cash each month.
 
You can consolidate various types of debt, such as credit card balances, student debt, auto loans, outstanding medical bills, and personal loans. You can get a debt consolidation loan through a bank, credit union, or other lender.

How to consolidate debt?

If you’d like to consolidate your debt, you have options.
 

Debt consolidation loan

Some lenders offer a special debt consolidation loan, which you can use to pay off your various debts. You’ll need to fill out an application and demonstrate to the lender that you’ll be able to make regular monthly payments. Debt consolidation loans sometimes require collateral on the loan, such as your car or bank account. Ask the lender if the loan is a secured (requiring collateral) or an unsecured debt consolidation loan.
 
Before signing, read the loan terms carefully. Some lenders try to entice you by offering a low “teaser” interest rate for a specific period. When that period ends, the rate climbs. In addition to paying interest, you may need to pay “points.” Each point equals one percent of the amount of money you borrow. So do the math to determine whether a debt consolidation loan is worth the interest and points you would pay.
 

HELOC for debt consolidation

If you’re a homeowner, you might consider a home equity line of credit (HELOC). This is a line of credit that uses your home as collateral. Most banks and mortgage companies offer home equity loans, which require an application and an appraisal of your property to determine how much equity you have. Typically, you can borrow an amount up to 80 percent of your home’s equity.
 
Because you’re offering your home equity as security, HELOC interest rates are generally lower than the rates for credit cards and certain loans. So, it might make sense to use a HELOC to pay off your student loan and high-interest credit card debt, for example. Keep in mind that you’re offering your home as collateral, so if you can’t make your monthly payments, you risk foreclosure on your home.
 
During your HELOC’s initial “draw period” (usually 5 to 10 years), you can withdraw money and typically pay only interest on the money you borrow. Your HELOC will eventually move into its repayment period. During this period, you repay the money you borrowed — making monthly payments that include principal and interest — and can’t borrow any more.
 

Credit card consolidation

If you’d like to consolidate credit card debt, you can transfer your credit card balances to a card with a lower interest rate. Some credit cards offer a low introductory interest rate — sometimes zero percent — when you transfer the balance from your existing credit card(s). Moving a balance from a credit card that charges 15% or 20% interest to one that charges 0% interest could save you hundreds (or even thousands) of dollars, depending on your balance. Most credit card companies ask you for basic information (your birth date, Social Security number, income), then transfer your balances for you. Or your credit card company may send you “convenience checks” that you can use to pay off your old balances; the amount of the checks is then added to the balance of your new credit card.
 
Keep in mind that there is usually a balance transfer fee, which is often either a percentage of the amount you transfer or a flat fee — whichever is more. Also, that low introductory interest rate only lasts for a while (such as six months), so it’s best to pay off the transferred balance before the rate rises. If you make a late payment — especially if it’s 60 days late — your interest rate may go up, even during the introductory period. And that introductory interest rate may not apply to new purchases.

Does debt consolidation hurt your credit?

It can—but it can also improve your credit rating.
 
Debt consolidation can help your credit rating if:

• you make your monthly payments on time. Making timely payments improves your payment history and can boost your credit score.
• you pay down your debt. Debt consolidation offers an opportunity to lower your interest rate and pay down debt more quickly. Reducing debt improves your credit utilization ratio, which raises your credit score.
• your consolidation plan expands your available credit. If you move your high-interest credit card balance to a new card that has a higher credit limit, for example, you’ll be using less of your available credit. That can improve your credit score.

Debt consolidation may hurt your credit if:

• you make late payments or stop making payments. Credit card issuers usually report late payments to the credit rating agencies, so they will show up on your credit report.
• the average age of your accounts falls. If you have 3 credit cards that are all 15 years old, and you get a brand-new consolidation loan or credit line — which is 0 years old — that new account lowers the average age of your accounts. This can affect your credit score, but usually just a little.
• you transfer your balance to a new credit card — and then max out that card. Consolidating your high-interest credit card balances into a new credit card can be a smart move. But if you then start shopping with that new card and run up the balance, it can hurt your credit rating.
• you close your old accounts. If you transfer your high-interest credit card balances to a new card, you may be tempted to cancel your old, high-interest cards. Think twice before doing so. You’ll have the same amount of debt as before, but less available credit. That raises your credit utilization ratio. A high credit utilization ratio (the percentage of available credit that you’re currently using) can lower your credit score.

How much debt do Americans have?

The average American has more than $105,000 of debt, according to Experian data. Student loan debt averages $35,208, the average auto loan debt is $24,297, and the average credit card debt is $6,730. Americans who have taken out personal loans owe $19,014, on average. Americans who have a mortgage owe, on average, $252,505 in mortgage debt.

Does debt consolidation hurt buying a home or car?

Taking out a debt consolidation loan won’t necessarily impact your ability to get a home mortgage or auto loan. However, it makes sense to plan.
 
When you apply for a debt consolidation loan, your lender will conduct a hard credit check. That may lower your credit score by a few points. That dip is temporary, so it’s best to take out any loans far in advance of applying for a car loan or mortgage loan.
 
Also, if you take out a consolidation loan that’s large enough to pay for your overall debt as well as extra expenses, you’re taking on more debt. That will show up on your credit report. Again, try to do this well in advance of buying a home or car. That will give you time to pay down some of your consolidation loan before applying for a new loan.
 
On the upside, debt consolidation can make your monthly payments more manageable. If you consistently make timely payments, your credit score may go up, helping you obtain a mortgage or car loan. A better credit score will also help you get a lower interest rate on a car or home loan.

What is debt settlement?

If you feel overwhelmed by debt, debt settlement reduces the amount of money you owe to a lender or creditor. You basically negotiate with your lender in hopes of paying less than the total amount you owe. You can either negotiate a debt settlement agreement yourself or you can enlist a debt relief company to negotiate with your creditor on your behalf.
 
When drawing up a debt settlement agreement, a creditor will typically expect you to pay a portion of your debt in a lump sum. Let’s say you have an $8,000 credit card balance, and your credit card issuer has agreed to accept $5,000. You would make a single $5,000 payment, and your creditor would consider your debt settled.
 
You might wonder why a creditor would accept $5,000 if you owe $8,000. If you’re making late payments or your debt has gone to collections, they might be concerned that you’ll file for bankruptcy. If so, they would rather get some of the money you owe than nothing at all.
 
Debt settlement reduces the total dollar amount of your outstanding debt. It differs from debt consolidation, which reduces the number of creditors you owe but does not lower your total debt amount.
 
Debt settlement may sound like a great solution, but it has its downsides:

• Your creditor may not be willing to negotiate. Each creditor makes their own judgment.
• You may pay fees of hundreds or even thousands of dollars if you hire a debt settlement provider to negotiate for you.
• You will pay taxes on your unpaid debt, which is considered income if it exceeds $600. So if your creditor agrees that you can pay $3,000 less than your outstanding balance, you’ll pay taxes on that $3,000 of forgiven debt.¹
• Your credit score may suffer. If you use a debt settlement company, they may ask you to stop making payments to your creditors. This gives them more negotiating power with your creditor — but it can also harm your credit score. Also, if you reach an agreement with your creditor, they may report the settlement to credit agencies and it will be on your credit report for seven years.

Beware of debt consolidation scams

Debt consolidation is a legitimate financial strategy. Unfortunately, scammers take advantage of people who are trying to take control of their debt. Scammers promise to help, then convince you to hand over your personal information or your money. So be aware of red flags that indicate you’re dealing with a scammer.
 
It’s a bad sign if a lender contacts you, rather than you reaching out to them. Also, if they have an unprofessional website — with misspellings or poorly formatted pages — the lender is likely a scammer.
 
Also, fraudsters tend to make big promises. They may offer to wipe out your debt quickly or clean up your credit report. If it sounds too good to be true, find a lender whose plan seems more down-to-earth.
 
Scammers may also use pushy sales tactics because they hope to seal the deal before you have time to research them. If a lender claims their offer is available for a limited time or otherwise pressures you, it’s best to walk away.
 
If a lender asks you to pay an upfront fee, you may be dealing with a fraudster who plans to take your money and run. Legitimate lenders don’t ask you to pay for a loan.
 
The lender has no office. If a lender can’t provide a physical address, avoid doing business with them. And if a prospective lender has no state license, they aren’t legitimate. Always ask for proof that they’re legally operating in your state.
 
Have questions or ready to begin? Learn about debt consolidation with Patelco.