The realization of heavy debt could put anyone in distress about selecting the best consolidation option. You can be successful in making your debt payments on time, but your high-interest rates can create a hindrance. It can also be difficult for you to afford more than the minimum payments.
Hence, you should understand the consolidation options so that you can choose the best one.
What is debt consolidation?
In simple words, debt consolidation is a method of “consolidating” or combining unsecured debts into a single monthly payment. You should also remember that consolidating your multiple unsecured debts doesn’t reduce your total debts. You only need to make payments on one account instead of multiple accounts.
Debt consolidation is the most helpful tool for paying off multiple unsecured debts in full. Through a debt consolidation method, multiple unsecured debts like credit card debt, payday loan debt, personal loans, utility bills, medical bills, are all combined into one single payment.
Debt consolidation is a sensible option for people who want to make one payment each month instead of several ones. The best debt consolidation solution is one that can ease your life or lower the cost of your debt payments.
One point to remember is that using a debt consolidation method is only possible for debts that are not tied up to any collateral. A private student loan, the amount owed on a credit card, a personal loan, are a few examples of unsecured loans that can fall under debt consolidation strategies.
What are the best ways to consolidate debt?
There is no hard and fast rule about which option will suit you the best. It is mostly dependent on your financial situation and preferences. Check out these unique and most popular options to consolidate unsecured debts:
- Credit card balance transfer
- Home equity loan
- A loan from relatives/friends
- Personal loan
- Loans from 401(k) or IRA
- Loan from insurance
- A secure loan (using a home or car as collateral)
However, you should have some knowledge about each of the debt consolidation options, their advantages, and the risks involved, so that you can choose the best one as per your financial condition and requirement.
Factors to check when choosing the best debt consolidation option
Now, one by one, we will be analyzing the advantages and risks involved in popular debt consolidation options.
Credit card balance transfer
This is one of the most popular methods to transfer one or many credit card debts with high-interest rates into a new credit card with a decent credit limit and a relatively lower interest rate. This can help you in saving money as the balance transfer is more convenient, and you can make just a single payment per month to consolidate your credit card debt.
This option helps cardholders to get out of the debt cycle which can be worse due to the added interest rates.
Using a balance transfer method as a credit consolidation option has its set of advantages. Here are a few listed below:
- You might be offered a 0% interest rate or a lower APR by the new bank on the transferred balance for a certain period, approximately 18 months max. Some credit card companies may offer you a 0% interest on your purchases too.
- For balance transfer, many banks also allow the customer to transfer his/her outstanding amounts and pay them back through low-interest EMI.
- A phone call or two can work for you. Since it is quickly processed, balance transfer makes it very convenient for customers to avail and get rid of pending dues. You might even ask for a waiver on transfer fees.
- You can easily transfer debts from one or more cards while making use of the credit card balance transfer feature.
Risk of a credit card balance transfer
- A balance transfer may be costly to you considering the balance transfer fee and the annual fee if the new credit card has one. Basically, this method works best when the transfer fee is low.
- A balance transfer method could also hurt your credit score. Applying for and opening a new credit card account can adversely affect your credit score.
- If you have a stained credit record, you might get unapproved for the card.
- Unlike a debt consolidation loan, credit consolidation through transferring your credit card balance doesn’t remove the debt from your shoulders. You are just shifting all the debt load to another credit card, not eliminating it.
**A word of wisdom…
You need to be cautious and focus on paying off the transferred balance as soon as possible, at least before the introductory period expires.
Consolidate through a debt consolidation loan
Check out the list given above. Apart from the 1st option (balance transfer), the rest of the options can be considered for taking out a debt consolidation loan. These options are quite beneficial when you have high-interest rate loans like a payday loan. If you’re able to take out a loan at a relatively low rate of interest, you can repay your existing debts with it. Your monthly payments will also be lowered to make it easier for you to afford your monthly bills.
Advantages of a debt consolidation loan
- You are making one payment instead of many when you opt for the debt consolidation loan option; so, there is a reduced risk of being late on monthly payments.
- When you take out a debt consolidation loan, you can pay off all your credit cards at the same time.
- You will not face any negative effect on your credit rating if you make all of your monthly payments through a debt consolidation loan.
- Home equity loans normally offer lower interest rates and larger loan amounts than other conventional loans like credit cards or personal loans. You might even get a tax deduction from the interest paid.
- Loans taken from friends or relatives come with zero credit checks and sometimes without any interest. If you have a bad credit score, this option is truly flexible and best for you to consolidate credit card debt and other existing unsecured loans.
- If you have a good credit score and a decent credit history, a personal loan a.k.a “signature loan” might come in handy for credit consolidation. It is an unsecured loan so you don’t have to put up any of your assets as collateral. Apart from that, it has a lower interest rate compared with payday loans or credit cards.
- Loans taken from retirement savings accounts like a 401(k) or an IRA comes with zero credit check. There’s no penalty for borrowing money from your deposited money in the Roth IRA.
- By taking out a secured loan (loan is taken against your home or your car) you’ll get a lump sum of money in your hand. By using the money you can wipe out your existing unsecured debts and get rid of multiple monthly payments.
- You may use your insurance policy to take out a loan and use the money to consolidate your multiple debts. The interest on this loan is cheaper than other conventional loans and with zero credit check.
However, there are risks involved with consolidating through a debt consolidation loan:
- If you are thinking of taking out a second or third mortgage to repay unsecured debt, and housing prices fall, you can end up falling into debt that is more than your house’s worth.
- If you withdraw retirement funds early from the 401(k), you might have to face penalties and pay taxes on the money withdrawn from the account.
- You have to roll over the money taken from your IRA within 60 days to make it interest-free. If you are not confident to do that, just avoid it.
- If you suddenly lose your job, you have to pay back the entire loan taken from the retirement fund immediately.
- If you can’t pay off your loans taken from friends or relatives, your relationship with them will be at stake. Also, your financial problems might get disclosed before society.
- You may put your house or car at risk if you use it as collateral.
- Insurance policies are made to serve you when you are in jeopardy. So, if you bet your policy to win the debt battle, you might remain empty-handed when a real crisis arrives.
- If interest rates rise, your monthly payments may also increase.
Debt consolidation program
Nowadays, there are numerous businesses out there eager to help customers in managing debts. How do you know which one is the best?
Reading reviews and looking for several accreditations can definitely help. Begin with organizations that have a strong reputation. It helps in lowering payments and the goal of eliminating debt can be easily met.
Advantages of a debt consolidation program
- Debt consolidation programs reduce collection calls, late fees, and penalties are also usually waived off.
- It combines all the debts into one big payment plan and you can repay debt with complete professional guidance.
- With the help of a consolidation company, you can set up a plan and payment system to eliminate debt within a set period.
Risks of a debt consolidation program
- You might be scammed if you don’t choose a reliable consolidation company.
- Debt repayment can be quite difficult as the process of debt consolidation program takes time.
Now, let’s see the whole picture at a glance…
Comparison between debt consolidation options
|Category||Debt Consolidation Loan||Balance Transfer Method||Consolidation Program|
|Monthly payment reduction||Yes||Yes||Yes|
|Unsecured debt repayment||Yes||Yes||Yes|
|Positive impact on your credit score||Yes||Yes||Yes|
|Credit check required||Not always||Yes||No|
|Continuing credit card usage||Yes (It’s better not to use it before clearing the entire debt)||Yes (It’s better not to use it before clearing the entire debt)||No|
|Complete professional guidance||No||No||Yes|
Compare and weigh the advantages and risks involved with each of the debt consolidation options before choosing one that may seem to you the best as per your financial condition.