A debt consolidation loan can be an efficient solution to sort out problems with existing debt. This solution allows you to repay all your current debts and replace them with one simple consolidation loan. Thus, you’ll have a lower monthly repayment and will repay less on your debt over time.
Like any lending product, loan consolidation does not work for everyone and sometimes it should be avoided because it could actually get you into deeper trouble. For example, you should not take out a debt consolidation loan when the interest rate is so high that your monthly repayment will be more than what you’re currently paying or when you can’t afford the new loan payments. Also, when the loan does not clear all your debts or when your monthly repayments are lower but the loan tenure is longer. The total amount you will repay in this case will be more than the original debt.
Let’s take a look at several things you should consider before choosing loan consolidation:
- Don’t opt for loan consolidation if it brings with it higher interest rates than those you are currently paying. You aim at decreasing interest, not increasing it. Sometimes, lower interest is a given. For example, most debt consolidation loans will come with personal loan rates that are much lower than those you will be paying on credit cards. But, if the debt you want to consolidate has low-interest rates or if your credit history is bad and you can’t get low rates, then loan consolidation will not work for you.
- Do not take out a consolidation product if it means you will be spending more on servicing your debt monthly than you are already doing. Your goal here should be to decrease your monthly repayment and ease your financial commitments. If a consolidation loan will cost more, you may need to find another solution.
- You should not take up a debt consolidation option if you cannot comfortably meet its repayments. This often happens in payday loans and people need to consolidate their payday loans This will only lead to more problems and you’ll find yourself in a worse financial situation. You should aim to have cash left every month after you’ve met all your financial obligations. If a debt consolidation loan won’t let you have spare cash every month, then avoid it.
- Look carefully at how long it will take you to repay the debt consolidation loan and how much you will repay in the end. In many cases, you’ll find that this can be a quicker and more cost-effective route for paying back your debt. However, a longer loan term can mean lower monthly repayments, it can also mean a higher overall repayment amount.
- If you currently have several unsecured debts and are encouraged to take out a secured loan to repay them, think hard before accepting this. It is true that your monthly costs may be lower, but you will need to put up your home or car as collateral. If your existing loans are unsecured, you don’t currently have that risk.
These loan solutions can work really well for some while being completely inappropriate for others.
Things to note when taking out credit card
Consolidating your credit card debt may be a good way to solve the challenges of high-interest debt. Thus, you can reduce interest rates and monthly payments, and repay your debt faster and more efficiently. However, when consolidation is not done correctly, it can lead to additional financial trouble.
Therefore, here are ten basic things to consider when using a credit consolidation program:
To stop accruing debt, stop spending excessively
When you consolidate, instead of balancing your budget, you continue to use your credit cards to get by every month. As a result, credit cards keep adding to the debt instead of reducing it.
When you’re consolidating your credit cards, you should stop spending on credit until you’ve cleared the consolidated debt. Otherwise, you’re just generating more debt and bills. You’ll eventually get to the point where your monthly debt payments need too much money.
If you don’t have good credit, don’t solve your problems on your own
Most people prefer to solve their debt problems on their own so they don’t have to tell anyone else about them. However, this will work only if you have a good enough credit score to qualify for the low-interest rates. If you consolidate with a higher interest rate, you won’t be able to pay your debt off efficiently.
You should try to consolidate at an interest rate that’s as close to zero as possible. So, if you’re doing a credit card balance transfer, you should aim for a card with a 0% APR introductory period. If you take out a personal debt consolidation loan, then you should aim at an interest rate around 5% and no higher than 10%.
- Don’t secure unsecured debt
This happens with people with a lower credit score consolidating on their own. They don’t qualify for an unsecured debt consolidation loan with lower interest rates because their credit score is too low. Therefore, they apply for something similar to a home equity loan instead, so that the debt is secured with their home as collateral.
Credit cards are unsecured debt. Therefore collectors may threaten to but they can’t actually take your property without a court order. On the other hand, a home equity loan may lead to foreclosure. That is not worth the risk just to repay your credit card debt.
Asking for help is a good idea
One advisable option when consolidating debt with a low credit score is credit counseling. Thus, you can check whether you qualify for a debt management program. That way you can roll all of your debts into a single monthly payment while reducing or eliminating high-interest charges. The low rates are guaranteed because the credit counseling agency negotiates with creditors on your behalf.
So, rather than securing unsecured debt with your house, you should look into a consolidation program through a credit counseling agency.
There may be hidden fees that add to the cost and it may take more time for you to pay off your debt. Most debt solutions do cost something, but the cost may vary, so check it before consolidating your credit card debt. Let’s say a balance transfer credit card usually has a 3% fee for every balance you move to that card. It may go up when you have higher debts or multiple debts on different cards.
For debt management programs, the fees are based on your budget.
Don’t give up and return to excessive spending
When people find out about consolidating, they’re excited to have a solution. Nevertheless, as time passes, some of them get tired of budgeting and after several months, they go back to excessive spending. This has a negative impact on their ability to avoid bankruptcy and their credit score.
When on a debt management program, they may drop off the program by the sixth month. However, remember that if you leave the program, your original interest rates and penalties can be reinstated. You have to stick with the consolidation program up until the end of it.
It is not the same as a settlement
There are commercials that urge you to “settle your debt for pennies on the dollar”. Don’t let them confuse you – that is different from consolidation. Consolidating credit cards with or without a debt management program and going through a debt settlement program are two separate things.
All consolidation options will pay off the debt in a way that works for your budget, meaning lower interest rates and lower monthly payments. That’s different from settling your debt for less than you owe. Consolidation helps you keep your credit score up as long as you keep up with your plan. Settlement always has a negative impact on your credit score.
Be alert to new financing
When turning to debt consolidation, there is nothing that can stop you from seeking financing – whether it’s for a new house, car, or a new credit card. You’ll be able to open new accounts and get approved for the loans you need. Actually, it may be even easier to get approved since consolidation will help with fixing your debt-to-income balance. If you use a debt management program, your credit cards will be frozen and you won’t be able to open new credit card accounts. However, you’ll still be able to get financing for a mortgage or auto loan.
You may be able to get financing, but this doesn’t mean that you should. Any changes to your debt while working to eliminate it should be avoided. You may take out a loan and also want to buy a new home or car, but proceed with caution. Therefore, it is advisable to consult a certified credit counselor. The advice is free and you can get an expert opinion on your situation.
Keep track of your credit once you repair it
Once your consolidation plan is completed and all your credit card debt successfully eliminated, you have to check your credit report to make sure it reflects the financial state you achieved. Creditors send the credit bureaus updates when an account has a change, but information transfer can sometimes be slower and you won’t immediately enjoy the benefits of eliminating your debt.
You should check the credit report for the following:
The account information should have been updated to reflect zero balances. If you go through a debt management program, the credit history of each account should reflect that you made all payments on time. If you paid off a collections account, it should be closed. If you negotiated to have that account removed in exchange for repayment, make sure it is actually closed. Check that all your account statuses are listed as current. Once the updates are verified, any outdated information will reflect your actual positive financial standing.
You should learn from your mistakes
To avoid finding yourself in the same situation six months to a year from the moment you repaid your debt, you should not get back to overspending and rely too much on credit cards. You won’t get penalized for consolidating or even consolidating multiple times, but this doesn’t mean that you should not avoid financial distress.
Once you’re out of debt, you should create a budget that allows you to reserve credit cards for strategic use and emergencies only. Also, establish an emergency savings fund to cover unexpected expenses without pulling out a credit card. Another advisable strategy is to keep an eye on your credit card debt ratio. Credit card debt payments should take up no more than 10% of your monthly income. If you spend more than 10% on them, you need to take steps to reduce your debt before resorting to consolidating again.
Student loan consolidation warnings
Student debt consolidation is highly advertised, but it may not be suitable for everybody. Although it has a 6-month grace period before the first payment on your loans after graduation, remember that if you don’t begin making payments after this timeframe, your interest will accrue and your debt will continue to grow.
The Consumer Financial Protection Bureau estimates that there is currently $1.2 trillion in outstanding student debt in the U.S.A. Around 7 million of the debtors are currently in default. This means a great potential for scammers. As debt grows, most debtors become overburdened, anxious and desperate and therefore very susceptible to trickery.
Most scammers aim at students during this six-month grace period before their first payment is due.
The upfront fee scam involves a “company” declaring that it can minimize interest rates for a low fee upfront. Actually, they are charging a premium fee for them to go to your lenders and arrange for some kind of debt forgiveness or consolidation. You can do this on your own without this fee.
No legitimate lender will require an upfront fee although some of them may require a percentage payment on your balance in the end. Private lenders might charge an origination fee, but this is negotiable.
- The elimination scam involves someone offering to wipe out your student debt. Actually, this is impossible because no one can eliminate your private student debt.
- Obama forgiveness scam. Although President Obama has put great efforts to ease the burden of student debt, you should familiarize yourself with his initiatives.
- Power of attorney is a dangerous scam and you should not sign papers allowing someone else to hold power of attorney over you without a lawyer present.
- If the consolidation company doesn’t provide information on phone numbers or addresses, this may mean that you are dealing with a fake consolidation company that is hiding behind a website. Every legitimate company should have a way in which consumers can contact them.
- Finding a reputable debt consolidation loan company:
- Check to see if they’re registered with the Association of Independent Consumer Credit Counseling Agencies and the National Foundation of Credit Counseling. They have lists of companies that offer legitimate debt consolidation services. Not all companies will be registered in either one of these databases, but many are and you can trust that they’re reputable.
- Check the Better Business Bureau website that lets consumers rate different businesses and allows users to search for any open court cases against companies. If a company doesn’t appear on the site, this doesn’t necessarily mean they’re not legit. However, those who have built up a reputation for scamming will usually appear there with bad ratings.
- Call your current lenders. Most of them are willing to work with you to come up with a plan for repaying because they would rather want their money back than to see you go into default.
Beware of companies that either make up a program that doesn’t exist, describes a government program like it’s their own, or says they have special methods to access it.
Call the companies through whom you already have loans and ask about any forgiveness or consolidation programs they have.
Don’t give anyone your social security number or bank account information via email, especially if their emails are written in poor English or deals that sound too good to be true because they are probably scams.
A consolidation company should be able to let you feel secure about refinancing. If after dealing with them, you do not feel at ease, you should definitely do a background check on them. Student debt consolidation should be a positive step toward getting out of debt.
I am David, economist, originally from Britain, and studied in Germany and Canada. I am now living in the United States. I have a house in Ontario, but I actually never go. I wrote some books about sovereign debt, and mortgage loans. I am currently retired and dedicate most of my time to fishing. There were many topics in personal finances that have currently changed and other that I have never published before. So now in Business Finance, I found the opportunity to do so. Please let me know in the comments section which are your thoughts. Thank you and have a happy reading.