Dana has been writing about personal finance for more than 20 years, specializing in loans, debt management, investments, and business.
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Many Americans carry some form of debt and will be familiar with the stress that high interest debt places on their lives. Debt consolidation can help you break free of high-interest debt before trouble arrives.
Here, we'll help you compare online debt consolidation lenders and find out who offers the best terms for your situation.
If you're asking yourself, "What is debt consolidation?" you've come to the right place. We'll tell you what it is, how it works, and how you can decide if it's right for you.
Debt consolidation involves taking out a new loan to pay off high-interest debt, such as credit cards and consumer loans. The key is to look for a lender with a low interest rate, low fees, and terms that will help you save money. That way you can retire debt faster and streamline your bill-paying process.
Although there's more than one way to consolidate debt, ultimately, each one involves transferring the debt. It's a matter of where you want to transfer it to. You have four primary options.
A balance transfer card is an excellent way to consolidate credit card debt. Balance transfer cards offer special promotional rates, such as 0% APR for a set number of months (typically 12-18). You apply online, tell the new credit card company how much you want transferred and from which cards, and wait for a response. You can transfer up to the amount you are approved for, but be aware that you may be charged a balance transfer fee of 3% to 5%.
For example, if you want to transfer $10,000 and the new card charges a 3% transfer fee, you would need to have a credit limit of at least $10,300 ($10,000 x 0.03 = 300). If your credit is good to excellent, you may be eligible for a card that doesn't charge a transfer fee. Make sure you have a plan in place to pay the card off before the promotional rate expires as the interest rate will likely rise drastically at that point.
Local and national banks, credit unions, online lenders, and peer-to-peer lending networks all allow you to take out a personal loan. The interest rates on personal loans are normally much lower than those on credit cards, but are still higher than the 0% rate you can enjoy through a credit card balance transfer. Personal loans typically offer repayment terms of between 24 and 60 months. However, the longer the term, the higher the interest rate some lenders charge. No matter which kind of lender you work with, your interest rate and repayment terms are based on your credit score, income, and debt-to-income (DTI) ratio.
If you owe less on your home than it's worth, that means you have equity and can borrow against it. A home equity loan allows you to transfer debt from one lender to another, just like a credit card transfer. Of course, you will pay more than the 0% interest associated with some credit card promotions, but will almost always get a better interest rate than you would with an unsecured personal loan. That's because your home acts as collateral and lenders view the loan as less risky. It's important to remember that missing home equity loan payments can put your home in jeopardy, so only consider this option if you're confident that you can keep up with the monthly payments.
The rules on borrowing money from your 401(k) have been temporarily relaxed under the CARES Act, which was passed in response to the novel coronavirus pandemic. Your 401(k) fund is an employer-sponsored retirement fund. If you take out a 401(k) loan, you are essentially borrowing money from yourself. You don't have to go through a credit check to do this and you would pay yourself interest on the debt.
Under normal circumstances, if your plan allows it, you can borrow 50% of your 401(k) balance or $50,000, whichever is less. The CARES Act allows you to borrow all of your balance up to $100,000. However, if you don't pay the loan back within five years, the IRS will count the borrowed money as a distribution and you will owe income tax and a penalty of 10%.
Be aware that taking money out of your retirement fund is risky because that's cash you will need when you retire.
A debt consolidation loan is a good idea when you can use it to pay off high-interest credit cards and loans. If you find a personal loan with a lower interest rate than you're currently paying, low fees, and terms that fit your budget, a debt consolidation loan can benefit you financially. Here's why: Say you have a credit card with a $10,000 balance and an interest rate of 17%. If you make payments of $300 per month, it will take 46 months to pay off the credit card, and you will pay $3,630 in interest.
Now let's say that instead, to pay off that $10,000 credit card debt, you take out a consolidation loan charging 6% interest. You decide to pay it off in 36 months rather than 46. Your monthly payment will still be around $300, but the debt will be paid off 10 months faster. In addition, because you have a lower-interest loan, you'll end up paying around $950 in total interest, rather than $3,630. That's a savings of $2,680. Even if an origination fee eats into the amount you save, you'll still come out on top.
A debt consolidation loan makes sense if one of these two points applies to your financial situation:
A debt consolidation loan is not right for everyone. If any of the following apply to you, it may be smarter to look for an alternative:
We now know that debt consolidation can lower the interest you pay, ease the hassle of paying bills each month, and help you pay off debt faster. But that's not all. Here are a few other advantages of debt consolidation:
The peril of living is that things can always go wrong. Here are some things that can happen to wipe out the potential advantages of debt consolidation:
If you're like most of us, an economic downturn or the pinch of a too-tight budget will make you consider your options. The most obvious alternative to debt consolidation is to adjust your budget or take on a side hustle to pay down your debt. However, it is possible that one of the following alternatives has crossed your mind:
Bankruptcy may sound like a tempting route. After all, who wouldn't want to wipe out all their debts at once? But bankruptcy has long-term financial consequences and should only be considered as a last resort. Not only will your credit score take an immediate hit, but the bankruptcy will stay on your credit record for at least seven years.
If your debt load is so heavy that you've considered filing for bankruptcy, make sure you've exhausted all other possibilities first. Let's say you have several high-interest loans and credit cards, and the minimum monthly payments are what's weighing you down. A consolidation loan may reduce your overall monthly payments enough to give you breathing room and allow you to pay off the debt.
Debt consolidation may also prevent you from going into debt settlement. Debt settlement companies work by calling your creditors and negotiating a lower interest rate and/or fees. Your job is to send the debt settlement company one payment each month. It then makes the agreed-upon disbursements to each of your creditors on your behalf. The problem is this: Those payments may be made may be long after the due date, resulting in delinquencies on your credit report. Like bankruptcy, these delinquencies stay on your report for seven years.
Some debt settlement companies may collect monthly payments from you for several years before negotiating with your creditors. That will mean that anyone reading your credit report will think you have made no effort to meet your obligations -- even though you've been diligently making payments.
If you're going to apply for a debt consolidation loan, it is helpful to have everything you need in front of you, including:
Debt you want to consolidate. Lenders also want a comprehensive list of each debt you want to consolidate, including the names and addresses of creditors and balances owed.
This debt consolidation calculator can help you figure out if debt consolidation would make sense. You will need to know the interest rate you're working with to make a good decision, but don't worry -- our selected personal loans for debt consolidation will only use a soft credit check to provide you a rate.
Very few Americans are immune from money problems, including debt they would love to jettison. When you're ready to get rid of high-interest debt, consolidation may be a relatively simple way to do it.
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