How to consolidate debt

How to consolidate debt. Pros, Cons, Risks, Types, and Where to get one. Debt Consolidation Loan. Balance Transfer. HELOC & HELOAN. DMP.

If you have a lot of debt, you might have come across the idea of consolidation. We are going to cover what debt consolidation is, how it works, whether it will be a good idea for your situation, how it will affect your credit score, how to get a debt consolidation loan, and what are the best debt consolidation loan companies.

We’ve spent years in the lending industry. We understand personal loans from the company perspective as well as the borrower’s perspective. With that experience, we are going to tell you what you need to know about consolidating debt. 

How Does Debt Consolidation Work?

The idea of debt consolidation is pretty simple: you combine several outstanding debts into a single personal loan. Let me give you a quick example. Suppose you have the following debts:

When you consolidate, you would take out a personal loan for just over $15,000 and use the proceeds of the loan to pay off all of these debts. You might wonder why you would bother to do that. Aren’t you just trading one debt for another? How does that actually improve your situation?

There are several benefits. The first one is that a personal loan has a fixed term length. That means that you will need to make steady progress paying off the debt. For a $15,000 loan, you would probably not want a term longer than 5 years. On the other hand, if you just make the minimum payments on your credit cards, you will be paying the debt for 10-15 years. So, the debt consolidation loan puts you on a track for significantly faster debt payoff.

The second thing about consolidating credit card debt is that you need to make sure that the APR of the new loan will be 2-3 percentage points lower than the interest rates of any of the loans you are consolidating. If you do that, more of your payment will be going to principal and less of it will be paying interest. That means you will pay off the debt faster and save money in the long run. 

The last benefit is that you no longer have to juggle multiple monthly payments. You just need to manage one payment. That’s nice, but it really isn’t a great reason on its own to consolidate. So, make sure you’re getting a good interest rate and a short loan term. 

There are four different ways to consolidate debt:

1. Debt Consolidation Loans: The most common method is using a personal loan. You borrow a lump sum of money to pay off your existing debts. You then pay off this new loan in monthly installments.

2. Balance Transfer Credit Cards: If you are consolidating credit card balances, you could transfer high-interest credit card debt to a new card with a lower APR. Some credit card companies will offer a 0% introductory rate for a set period, usually 6-18 months. This gives you a chance to pay down the debt without accruing additional interest, though a balance transfer fee of around 5% will apply.

3. Home Equity Loans or Lines of Credit (HELOCs): You could borrow against the equity in your home to consolidate debt. This option often comes with lower interest rates but puts your home at risk if you fail to repay the loan. You can also usually borrow greater amounts when you secure the loan. This can help if you can’t qualify for enough money with an unsecured loan__to consolidate all the debt you want to include.

4. Debt Management Plans (DMPs): These plans are typically offered by credit counseling agencies. The agency negotiates with your creditors to reduce your interest rates and consolidates your payments into one monthly payment that you make to the agency, which then distributes the funds to your creditors.

Is Debt Consolidation a Good Idea?

Debt consolidation can be an effective way to save money on interest and accelerate your efforts to pay off your debt. However, whether it’s a good idea for you will depend on your personal financial situation, the kind of deal you get, and how well you manage the loan.

Pros of Debt Consolidation

There are several pros of debt consolidation.

• Simplified Payments: Instead of multiple due dates and creditors to keep track of, you’ll have one payment to make each month.
• Lower Interest Rates: If you qualify for a loan with a lower interest rate than what you’re currently paying, you can save money on interest.
• Fixed Monthly Payments: A debt consolidation loan is amortized which means that the interest rate, payment, and terms are all fixed at the beginning of the process. 
• Quicker Repayment: Some debt consolidation options, like personal loans, may have shorter repayment terms, helping you pay off your debt faster.
• Smaller Monthly Payments: Most debt consolidation loans will have smaller monthly payments than what you are currently paying. That can give you a little breathing room in your finances.

Cons of Debt Consolidation

The cons of debt consolidation include:

• Qualification Requirements: If you have poor credit, you may not qualify for a low-interest consolidation loan. If you can’t get loan with an APR of at least 2-3 percentage points lower than the interest rate on your current debts, don’t consolidate. 
• Fees: Balance transfers and home equity loans can come with fees, which might offset some of the savings from consolidating.
• Temptation to Accumulate More Debt: After consolidating your debt, you might be tempted to start using your credit cards again, which could lead to further debt accumulation.
• Longer Payoff: If you consolidate a personal loan, you might roll that debt into a consolidation loan with a longer term. It’s possible that you would be delaying the time you are out of debt by consolidating. 

What Are the Risks of Debt Consolidation?

While debt consolidation can help make your financial life easier, it is not without risks. 

Losing collateral

If you consolidate using a secured loan, like a HELOC or HELoan, you could risk losing your collateral if you run into trouble repaying. 

Extend payment terms

Also, if you are not careful, a debt consolidation loan could extend your repayment period. That can lower your monthly payment, but it would probably result in paying more interest over time, even if the APR is lower. 

Increasing your debt

Another risk is increasing your debt load. There is often a temptation to take out a loan that is bigger than what you need. Or to free up credit card balances and start spending again. If either of those are a serious temptation to you, consolidating could make your financial situation worse. 

Added fees

There is a risk that you could also incur unexpected fees. If you are using a traditional personal loan to consolidate, all unavoidable fees should be represented in the APR. But if you are using a credit counseling agency, they might charge you a fee for their services that is not accounted for in the loan. 

Impact on your credit

Consolidating could also affect your credit. This cuts both ways, actually. It could improve your credit score, but it could also hurt it. In fact, let’s get into to that right now. 

How Does Debt Consolidation Affect Your Credit?

Credit scores are really complicated. There is no way for us to tell you exactly how debt consolidation would affect your particular situation. But, we can tell you the *ways it would affect your credit report–and the likelihood of those ways to significantly impact your credit score. Let’s start with the ways that it could be beneficial to your credit score. 

Positive Impact on Credit

In our analysis of millions of credit files, we found that there is a linear relationship between your credit score and your credit utilization. Utilization is the percentage of your available credit you are currently using. If you consolidate credit card debt, you are effectively dropping the utilization of those cards to 0%. That should have a very positive impact on your credit score. 

The most important factor to a strong credit score is having an unbroken history of on-time payments. If consolidating your debts can help you avoid being late on any of your payments, consolidating could help you steadily improve your credit. 

Negative Impact on Credit

Now let’s look at the ways consolidating could hurt your credit. When you take out a new loan, the lending company will put a hard inquiry on your file. Hard inquiries can hurt your credit score up to 15 points for a few months. As long as you aren’t regularly adding hard inquiries, this effect should fade within three months. 

The other thing adding another loan could do is drop your average age of credit, especially if you close any of your other accounts. If some of your debts are credit cards without annual fees, you could keep them open and put them aside. Or use them for a single purchase every month and pay the balance in full. That could offset the impact of drastically changing your credit mix too quickly. 

Finally, like any debt, if you are late on any of your loan payments, it will hurt your credit score. Every time a payment is reported 30-days late, it is a meaningful negative hit to your score. 

How to Get a Debt Consolidation Loan

When you are looking for a debt consolidation loan, the most important thing you can do is to shop around. You never know which lenders will approve you and who will give you the lowest rate. If you can, get 2 or 3 offers in hand before you decide to take a loan. 

At The Yukon Project, we’ve tried to make shopping around easy. If you are looking for a debt consolidation loan, you can visit our loan marketplace page. There, you can select “debt consolidation.” You can then apply to any one of the featured lenders. Behind the scenes, we will check your rate with up to 40 other lenders. Our partners use a soft credit check, so applying won’t hurt your credit score. We will show you all of the approved offers so you can make sure to pick the loan that’s best for your situation. 

If you want to check to see if transferring your balance to a new credit card with an introductory rate is best for you, we’ve got that covered, too. You can visit our credit card marketplace. There, we have over 150 credit cards with their latest offers. You can scroll through and find the opportunity the best meets your needs. 

What Is the Best Debt Consolidation Company?

Choosing the right debt consolidation company depends on your needs, financial situation, and preferences. When we track debt consolidation companies, we look for companies that have features that help people who are consolidation, like the ability to add cosigners, direct debt payoff, and other low fees. 

If you have good to excellent credit, some of the best companies for debt consolidation include: Discover, Happy Money, Sofi, TD Bank, and Wells Fargo. If you have fair to good credit, some of the best debt consolidation companies include: Achieve, Best Egg, LendingClub, and Upgrade. 

Conclusion

Debt consolidation can be a helpful tool for managing debt, but it’s important to weigh the benefits and risks before making a decision. If you have any experience with debt consolidation, please consider leaving a comment below. At The Yukon Project, we are building a community of people who can pool their experience so we all can be better informed when making decisions about our personal finances. If you found this information useful, please like this video and subscribe to our channel.

See if you can get approved for a debt consolidation loan. Soft credit checks. Upto 40 options.