Debt consolidation can provide a way for you to get relief from your debt burden, but only if it’s the right solution for you.
How do you know if a debt consolidation program is right for you?
Much of this depends on whether you change your spending habits, better manage your finances, and find a reputable company to help you get out of debt.
What Does Debt Consolidation Mean?
Before you decide to consolidate your debt, you need to understand what this process means.
Debt consolidation is the process of taking multiple, existing debts and turning them into one combined debt. Think of it as taking several of your monthly bills, wrapping them into one, and having only one bill to pay each month.
Debt Consolidation Is Not the Same as Debt Management
Debt consolidation is not the same as debt management, and it’s not the same as debt settlement. Debt consolidation involves the following:
1. Gather all your unsecured debts such as credit cards, other loans, and debts that may have been sent to collections, such as medical debt.
2. Apply for a debt consolidation loan, a zero-interest credit card, or a home equity loan taking to cover the costs of your debt.
3. Start making one payment a month to the new loan you’ve acquired because you’ve reduced the number of loans (and payments per month) you have to one.
Debt Consolidation vs. Debt Management: What’s the Difference?
A debt management plan is typically when you contract with a company to manage your debt for you. You make one payment each month to the company, which then distributes the money among your creditors.
While debt consolidation will pay off your debts by trading several loans for one, debt management involves a debt management company acting as an intermediary to negotiate a payment plan and lower interest rates for all your debts.
You still owe on multiple accounts, but as part of your debt consolidation service package, the debt management company handles payments on those accounts for you.
What Is Debt Settlement?
With debt settlement, a debt relief company negotiates with your creditors so you can make a single “lump sum” payment to resolve your debt.
The debt settlement company also manages the monthly payments you make into an escrow-like account that will be used to save enough money to make the lump sum payment.
You don’t necessarily need a debt settlement company to help you with this, however. You can try negotiating with your creditors to accept less than what you owe as payment in full for your debt.
There are a few important things to know about settling your own debts.
1. It usually requires a lump sum payment to your creditors for them to consider the debt paid off.
2. Depending on how much you owe, this lump sum could be hundreds or thousands of dollars, so you’d need to have that cash on hand in order to make debt settlement work.
3. Get it in writing from your creditor that by paying this lump sum, they are considering the debt as paid.
The Different Types Of Debt Consolidation
There are a number of debt consolidation programs, each with its pros and cons.
Debt Consolidation Loan
When you take out a debt consolidation loan, the funds you borrow are used only to pay off your debts.
If you’re thinking about applying for a debt consolidation loan, you should keep in mind that a secured loan (one that’s backed by assets, like a house or car that you own) means your possessions may be at risk.
Unsecured debt consolidation loans are available, but the trade off in not having to use your home’s equity as collateral to obtain the loan is a higher interest rate than what you might pay on a home equity loan or a mortgage cash-out refinance.
If your main concern in consolidating your debt is making sure you have a lower monthly payment on your debt, you can usually lower your monthly payment on the debt consolidation term by getting a loan with a longer term. The term is the amount of time it will take to pay the loan off. So, for instance, you could have a term of five years, instead of three, to get lower payments.
There are a few downsides to this.
1. You will pay more in total interest because you’ll be paying for five years instead of three.
2. Even though you are making a lower payment, it will take you longer to pay back the debt consolidation loan.
3. A debt consolidation loan acts to basically move your debt around from several accounts to one. You still owe the same amount of money, you’ve just changed how you’re paying it off to improve your financial health.
4. Unless you change your spending and saving habits, you may find yourself in debt yet again.
Credit Card Balance Transfer
Most people have multiple credit cards. For some, transferring existing balances to a card with a low balance transfer interest rate and a higher credit limit works to consolidate their debt.
However, saving money isn’t guaranteed with this tactic. You will need to fully research all fees and interest rates and be sure that you’ll be able to keep up with the payments on the credit card to which you make the transfer.
In addition, you should check to make sure that having a high credit card balance wouldn’t negatively affect your credit score.
A balance transfer may result in a high balance that indicates to the credit bureaus that you’re carrying too much debt.
Second Mortgage, Home Equity Loan, or Home Equity Line of Credit (HELOC):
While using your home to get out of debt is an option, it can be a risky one.
If you are unable to make the payments on these types of loans, you might lose your home.
Home equity loans and credit lines might have lower interest rates, but the trade off might not be worth it. That’s because a second mortgage, home equity loan, or HELOC requires that you use your house or apartment as collateral for the loan. Even late payments may put the ownership of your home in jeopardy.
Life Insurance Loans
Some types of life insurance policies will allow you to borrow money against them, but just because you can borrow money from your life insurance policy doesn’t mean you should.
These life insurance policies have a quick-cash loan option, but this is something that should only be considered in an emergency.
Debt consolidation, while important and urgent to take care of, isn’t an emergency.
The tax implications of borrowing from life insurance are one of the biggest, hidden reasons not to get a life insurance loan.
Retirement Plan Loans
Borrowing from a retirement plan like a 401(k) can be tricky.
Certain retirement plans don’t allow for loans and withdrawing any amount of money can result in penalties and additional taxes that will put you further in debt.
Other plans do allow for retirement loans, but you will wind up missing the interest you could be earning on that money.
Also, there may be fees involved in taking out a loan on a 401(k) or a 403(b) plan.
Another loss to consider: when you are able to pay back your retirement loan, you may not recoup the lost interest.
The Bottom Line
Not every option for consolidating your debt will be the right one for your financial situation.
In getting control over your debt, it may even turn out that there are debt consolidation programs you never considered.
AmONE’s free service can help you with understanding all of the advantages and disadvantages of debt consolidation and all available debt consolidation programs.
You can call AmONE toll-free at 888-401-0330 to speak with one of our knowledgeable financial search specialists.
You can also complete our simple, online debt consolidation loan form so we can instantly match up you with the best debt consolidation program for your financial needs.
