What Is Debt Consolidation?
Debt consolidation is the process of putting all of your debts together and making one loan payment each month to pay it off. The process can be an easy to use solution for those who are able to qualify for it. There are two main methods to debt consolidation – a loan and a debt counseling service. It is important to understand the differences in these. For many people, the consolidation process can help them to get out of debt faster while preserving their credit scores. However, it is a big decision to make and making a mistake could lead to further complications.
Debt Consolidation Loans
One of the easiest ways to consolidate your debt is through a loan. In short, you will take out a new loan, a large enough one to cover the current debts you have. You will use the proceeds from that loan to pay off all of your other debts. This process allows you to put all of the debt you owe into one new loan. This can make it easier for you to pay off the debt each month.
There are numerous ways to get this type of loan. Consider the following and if you will qualify for this method.
- If you have the ability to obtain a large, unsecured loan, this is the best route to take. Keeping your unsecured debt unsecured can actually help to protect any assets you own. However, if you already have a lot of debt, or a bad credit score, finding a large enough credit card or personal loan to allow this can be very difficult.
- Tap into the home equity you have. If you have equity in your home, which is the un-mortgaged value in your home, you may be able to refinance your loan, or take out a home equity loan to consolidate debt. This will allow you to get a low interest rate on the loan, but it can be a tricky move. The problem is that you are putting your home on the line for your debt. If you fail to make your credit card payments, as they stand, the lenders are unlikely to be able to come after your assets. If you consolidate using a home equity loan, your home secures the debt and your lender can foreclose if you stop making payments.
In either of these options, you are obtaining a new loan to pay off your existing debt. This has both advantages and disadvantages.
- You will protect or even boost your credit score in the process. You will be opening up new credit and expanding your debt to credit limit ratio.
- You are not paying less than you owe. You will pay off what you owe.
- You could position yourself to double what you owe if you allow credit cards to remain open after consolidating and use those credit cards again. Avoid using those accounts after you consolidate.
You will still need to make payments on time. You will need to qualify for this type of loan to get it, too. If you are struggling to keep up with payments or you have a low credit score, these new loans are unlikely to be available to you from lenders. This can be troublesome for individuals who want to get out of debt.
Debt Consolidation through Credit Counseling
The term debt consolidation is also often used to describe the credit counseling process. In this case, you are not obtaining new credit. Rather, you will work with a debt counselor over a period of three years or so to pay back your lenders what you owe to them. In this method, the goal is to reduce what you owe and to set up a payment plan to pay it off. Here is how it works.
- You work with the debt counselor to determine what your budget is. This budget shows how much extra money you have left over each month that you could use to pay towards the debt you owe.
- The debt counselor contacts each of your lenders and tries to negotiate a lower monthly payment, reduced interest rates and a reduced overall debt. The goal is to ensure that each of your lenders can require a low enough payment to fit into your discretionary funds, or the amount you can pay each month towards your debt.
- If the lenders agree, you will make payments to the debt counselor each month. The counselor will then pay each of your lenders on your behalf. This continues through automatic payments each month until what you owe is paid in full.
Under this method, you are able to get out of debt over time. You may end up paying less than what you owe. The lender may place a negative mark on your credit initially but as you make your monthly payments, your score may improve over time. In many situations, you will need to have income and have some discretionary income to pay towards your debt.
Choose Your Method
Which method is right for you? If you qualify for a new loan, that method may be the best method to take if you want to preserve your credit over the long term. On the other hand, if you do not have the ability to obtain a new loan, or you do not want to go that route, using the debt counseling method may offer a solution. For many people, this is the option to take to avoid filing for bankruptcy.
Take the time to consider all of your options. If you cannot get your debt under control as it is, either of these methods can help you to get out of debt faster. Take into consideration your long-term goals. Will you be able to pay off your debt in five years under the method you are using right now? If not, consider how debt consolidation can help you to finally get out of debt and on the road to wealth.