Is Debt Consolidation Right for You? | If you have multiple credit cards, use them all and rarely pay them off, you may find it difficult to get hold of your debt. Sending payments to various companies can make it hard to track your finances. Seeing the big picture can be a challenge with your money going in so many different directions each month.
Some consumers find that debt consolidation is the answer to this situation. If you’re struggling to make minimum payments or figure out exactly how much money you owe, debt consolidation may work for you.
What Is Debt Consolidation?
Debt consolidation helps you organize your liabilities. The idea is to eliminate multiple accounts and combine them into one payment at a lower interest rate than you’re currently paying. While consolidation works best for high-interest credit card debt, in some cases, you may include other types of debt such as personal loans, medical bills or student loans. Once you reduce your accounts to a single payment at a lower interest rate, you can simplify your bill-paying strategies and pay off your debt more quickly.
What Consolidation Method Is Best?
The consolidation method you choose depends on your financial situation. Each option has pros and cons, and not all choices will work best for you. You should look for a method that offers:
- Little or no impact on your credit score
- Few or no associated fees
- Free consultation
- A path to complete debt payment in three to five years
- Easy enrollment
What Are the Most Common Debt Consolidation Options?
One method of debt consolidation is a credit card balance transfer. This is more of a DIY method of consolidation. Many credit card companies offer balance transfers with a period of no interest payments. It is a strategy to attract new customers, but it does come with a transfer fee, usually around 4%. You also have a limited time — typically 12-18 months — to take advantage of the 0% interest rate. The balance transfer method may work for you if you’re able to pay off your debt during the grace period and can afford the transfer fee. However, you usually need to have a credit score of 680 or higher to qualify.
A debt management program is another option. Nonprofit credit counseling agencies offer these programs. They employ certified counselors to advise you on your financial circumstances and help you decide the best relief option. Counselors can also teach you how to avoid debt in the future. Their initial services are free of charge. Enrolling in a debt management program eliminates calls from collection agencies. However, you pay a monthly fee for using the program and will probably be required to close your credit card accounts. Your credit score may dip initially before recovering and improving.
Borrowing from your retirement plan is another option to consider. If your employer allows this method, you can borrow the lesser of half of your vested balance or $50,000. Most plans charge interest, and you must repay the loan within five years. If you leave your job before you repay it, you have until your next tax return to pay back the money or face early withdrawal fees. However, since the money is yours, you won’t pay loan origination fees, and the interest is added to your account.
Home equity loans are a risky but low-interest way to consolidate your debt. Your residence is used as collateral for this loan, meaning that you can lose your home if you cannot repay the loan. A home equity loan uses the current value of your home minus the amount you owe. If your home is worth $300,000, for example, and you owe $200,000, you have $100,000 of equity from which to borrow. This type of debt consolidation can work for you if you’ve paid off a lot of your primary mortgage or your home has considerably increased in value.
Debt consolidation is a good way to simplify bill paying and help you get out of debt faster. Before choosing a debt relief option, review your choices thoroughly to make the best decision for your circumstances.