Just as there are many reasons why people end up in debt, there are many ways to handle getting out of debt. One option is debt consolidation, which means rolling up several of your debts into one, lower-interest loan.
The ideal person for this type of debt management solution is someone with a fair amount of high-interest credit card debt who has a good credit score and the ability to be disciplined financially, says Christopher Viale, president and CEO of Cambridge Credit Counseling Corp. Here are five steps to making debt consolidation work for you.
1. Understand your debt
If you’re not sure how much debt you actually have, and how much interest you’re paying each month, you need to get a handle on those numbers before you can decide if debt consolidation makes sense for you.
The main goal of debt consolidation is to get a more favorable interest rate so you can make your monthly payments more easily and hopefully pay down your debt faster. Keep in mind: These loans are only for unsecured debt, meaning debts that aren’t secured by collateral like a house or car. Debt consolidation also won’t lower the overall amount of debt you owe, just how much you owe in interest and possibly in fees or penalties.
2. Decide if you’re a good candidate
If after looking into your debt you believe debt consolidation is a good fit, then it’s time to see if you yourself are a good fit.
Because you may be taking out a new loan, you’ll need a good credit score to secure an interest rate that would make debt consolidation worthwhile. That could mean a credit score of 680 and above to get a loan with a favorable interest rate, Viale says. Credit unions may be more willing to work with you if your credit score is lower. You also can try to get a secured loan (one where you put down collateral like a house or car), but those are very risky because you could lose your collateral.
You also need to be financially capable of paying off the new loan every month. Make a budget and determine what you can afford to pay monthly toward your debts. Be as realistic as possible: Taking on a monthly payment that you can’t afford is only going to compound your debt problem.
3. Figure out which type of debt consolidation works best
A debt consolidation loan from a bank or other lender is not your only option for consolidating your debt. Research the options before deciding which is the best for you debt situation. Here are the main types of debt consolidation:
- Debt consolidation loans: These are installment loans offered by banks, credit unions and online lenders that usually have lower interest rates, but may have longer repayment periods. This means you could pay more interest over time. Interest rates can be fixed (they don’t change) or variable (they do) over the life of the loan. You’ll want to know how much interest you’ll pay for the entire length of the loan to know if it’s actually a better deal.
- Home equity loan or auto loan: These are secured loans that borrow against the equity you’ve built in your home or car. These loans will usually have lower interest rates than unsecured loans, and can be easier to get, but the big, big risk is you could lose your car or home if you default on the loan.
- Balance transfer credit card: If you can get a credit card with a 0% interest introductory rate, you could transfer your balances from higher-interest credit cards to this card. But these offers almost always expire, so this only makes sense if you can pay off most or all of your debt before the offer ends. Plus, some cards charge you fees each time you transfer a balance. The upside with this option, of course, is you could possibly pay down your debt without paying any interest at all.
- Personal loan or borrowing from friends and family: If you want to get your debt paid off more quickly, you might think about getting a personal loan from a lender or borrowing money from friends or family. Your credit score and how quickly you need the money will determine which option is more viable. If your credit score is below 680, that could make it harder for you to get a personal loan, Viale says. And even if you are approved for a loan, the interest rate might be similar to what you’re paying on your credit cards. As for getting a loan from a friend or family member, treat the loan the same way as you would one from a bank and make sure everything is in writing and you can meet the terms of the deal.
4. Go shopping
Get out your calculator because it’s time to do the math. If you’ve chosen a loan to consolidate your debt, you’ll need to figure out how much interest you would pay. That’s because the goal of debt consolidation is to lower your monthly payments and hopefully make paying off your debt less expensive overall. Make sure that the rates being offered aren’t “teaser rates” that will expire. Find out if the interest rate is fixed, meaning it won’t change, or variable. Also ask if there’s a penalty if you pay off your loan early.
The second thing to consider when shopping for a debt consolidation loan is how long you will be in debt. To get a better interest rate you may have to extend the term of the loan, which means you will stay in debt longer. But if that allows you to pay off your debt without missing payments, it could make sense in the long run. Finally, you should never work with a company or lender that guarantees you will get a loan if you pay them a fee upfront.
5. Stick to the plan
Once you’ve chosen a loan that’s right for you, you’ll start making one monthly payment on the loan that includes your rolled-up debts. Be smart about your spending so you can afford your payments each month.
You may have to do some belt tightening, but if you can pay off your debt more easily and affordably, it will be worth it.
How Resolve can help
If you’re dealing with debt and not sure what to do, we’re here to help. Become a Resolve member and we’ll contact your creditors to get you the best offers for your financial situation. Our debt experts will answer your questions and guide you along the way. And our platform offers powerful budgeting tools, credit score insights and more. Join today.