The Top 4 Ways to Consolidate Debt

Debt is an inescapable part of life for many Americans. A shocking 80 percent of the population holds some form of debt. If you are falling behind on payments or feeling overwhelmed, there are a variety of debt relief options. Debt consolidation is one of many ways to deal with debt.

Debt consolidation is the process of combining multiple bills into one monthly payment. There are four main strategies: balance transfers, personal loans, home equity loans, and debt management plans. The type of strategy you use will largely depend on your credit score and whether you want to do it yourself or work with a professional.

Balance Transfer

balance transfer involves paying off debt with a low or zero percent APR credit card. This reduces or eliminates interest rates, allowing you to pay off your debt more rapidly, ultimately saving you hundreds to thousands of dollars in interest.

Many credit cards advertise a promotional or introductory period, ranging from six to 24 months. During this time interest rates are low or even non-existent. However, most credit cards charge a balance transfer fee, often 3 to 5 percent of the transferred debt.

Balance transfers have several limitations. Firstly, every credit card comes with a credit limit. If your debts exceed this amount you will not be able to consolidate all your debt on one card. Also, when the promotional period is over the credit card will often return to normal interest rates. Additionally, if you miss a payment you may no longer qualify for the advertised rate.

Balance transfers may also impact your credit score. It is important to be mindful of your credit utilization ratio. Part of your credit score is determined by the percent of available credit that you currently use. It is recommended to keep this ratio under 30 percent. If you receive a credit card with a credit limit of $10,000 and use it to pay $9,000 in debt, then your credit utilization ratio is 90 percent, for that card. It is important to be mindful of this when deciding if a balance transfer is a good option for you. Furthermore, opening up a new account could negatively impact your score if you recently opened up others lines of credit.

Finally, zero balance credit cards may have high credit score qualification requirements. Before choosing a balance transfer, determine what your new interest rate will be, including any transfer fees, to help you decide if it is a wise financial move. If you cannot get a lower interest rate you may want to consider other options.

Balance transfers may be a desirable option if you have a high credit score. To fully utilize this option you will want to pay off your debt during the promotional period. If you can stick to a budget and strict payment plan, this may be a great option for you.

Personal Loan

If you are leery about opening a new credit card you may want to consider a personal loan. Many companies even specifically advertise loans for debt consolidation. Personal loans often provide lower interest rates than standard credit cards. However, rates vary greatly based on the qualifications of the borrower, ranging from two to 36 percent. If you are interested in a personal loan you will need to examine your credit worthiness. Personal loan companies often look at your credit score, credit history, debt-to-income ratio, and total household income. If you are an ideal candidate you could potentially receive advantageous rates.

However, personal loans may include other fees such as origination fees, prepayment penalties, etc. All of these fees should factor into your decision. Additionally, personal loans have a set payment period. This may help you stay on track and get out of debt in a set period of time, often three to five years, with an affordable monthly payment. They also allow consumers to borrow large amounts, some even as high at $100,000.

If you have a high credit score, a personal loan may be a great option for you. It will allow you to pay your debt off at a fixed rate over a set period of time. You also have the option to borrow a large amount to cover all of your debts.

Home Equity Loan

Home equity loans work similarly to personal loans. You borrow a fixed amount and repay it over a certain period of time. However, with a home equity loan, you are borrowing against the equity in your house. This type of loan is considered secured debt; therefore if you default on your loan the lender can foreclose on your house. According to Magnify Money, these loans typically have lower interest rates and longer term limits. However, your credit history will impact your rate. Additionally, the loan amount is dependent on the equity you have in your home. Therefore, the loan amount may be greater than that of personal loans.

Similar to personal loans, there may be additional fees including origination, broker, or document preparations fees. You may also have to pay an appraisal fee because the loan is contingent on the market value of your home. However, the interest is often tax deductible up to $100,000, for married couples filing jointly.

Home equity loans may be a good option if you have a substantial amount of equity in your house and a high credit score. They offer low tax-deductible interest rates and allow you to borrow large sums.

Debt Management Plan

Another common method for consolidating debt is a debt management plan (DMP). During this option, you work with a certified credit counselor. Most credit counseling agencies offer a free consultation where they review your debt, income, budget, and credit history. Then, they create a plan to help you get out of debt.

Debt management plans typically take 36 to 60 months. These companies often negotiate with your creditors to help lower your interest rates. You will often pay the agency, one monthly payment, and then they pay your creditors. Though many companies are non-profit organizations they still charge monthly fees. These fees typically range from $25 to $55 per month. Some companies also charge setup fees, averaging around $75.

In addition to creating a payment plan, your certified credit counselor can also help you create a budget and learn strategies to stay out of future debt. The plan and service are individualized to meet your specific needs.

It is important to note that during a debt management plan you are usually prohibited from opening new lines of credit and using your credit card. If you are asked to close lines of credit it could negatively impact your credit score.

A debt management plan may be a good option if you have high debt and are considering bankruptcy. You can enroll, even if you have a bad credit score. The company will help negotiate lower interest rates lowering overall payments and provide financial literacy education.

All four debt consolidation strategies have advantages and disadvantages. Consider your individual circumstances, particularly your amount of debt and credit score before deciding on a strategy. One of the best things you can do is run the numbers and determine which strategy will save you the most long-term, including interest rates and associated fees.

Author Bio: Amber Westover manages the debt blog at Best Company. She specializes in debt and personal finances. Amber is passionate about learning and researching. 

Written by Jon the Saver

This post was written by yours truly, Jon Elder. My mission is to help you succeed in your personal finance life. Join me on the journey to financial freedom! You can subscribe through RSS FEED or EMAIL updates. You can also find me on TWITTER
. Happy investing 🙂

Jon the Saver

This post was written by yours truly, Jon Elder. My mission is to help you succeed in your personal finance life. Join me on the journey to financial freedom! You can subscribe through RSS FEED or EMAIL updates. You can also find me on TWITTER and FACEBOOK . Happy investing 🙂

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