How To Consolidate Debt

If you are in debt that is over your head, there may be some debt relief options for you.  Debt consolidation loans can be a great way to lower your interest rate and also lower the monthly payments on your debt obligations. Sometimes it can be your savior and the best way for you to avoid bankruptcy.  It can be a vehicle for getting out of debt if done right.  Here are some tips you need to know on how to consolidate your debt.

What Is Loan Consolidation

Loan consolidation is the process of combining debt from multiple (high interest) sources into one low interest debt source.  This could mean combining all your credit card and other debts into a personal or home equity loan or combining all your credit card debt onto one low interest credit card.

Secured and Unsecured Debt Consolidation

• Unsecured debt consolidation loan

These are very common types of debt consolidation loans.  What an unsecured debt consolidation loan essentially means is that you do not need to have collateral in order to obtain the loan.  So if you do not honor your debt obligations, you won’t lose your properties and belongings.  But what will happen is that your account will go to collections and your credit score will plummet.  A typical unsecured debt consolidation loan is using a personal loan to consolidate your credit card debt.

• Secured debt consolidation loans

Secured debt consolidation loans are loans in which the bank is required to put a lien on your property (such as your car or house) in order to cover potential losses if you do not repay.  Personal loans sometimes require collateral and are a great option if you are looking for a loan to consolidate small debt.  It is often used for as a loan for consolidating your credit card debt.  But for larger debt (more than $10,000) most people opt to do a mortgage refinance or a home equity loan/line of credit.

Sources For Loan Consolidation

There are various ways to consolidate your debt and the best choice for you will depend upon your current financial situation and how much debt you have.  We will outline a few ways to consolidate debt below:

Personal Loans and Social Lending

For consolidating small credit card debt, you may want to consider a personal loan.  The personal loan traditionally has come from large banks and credit unions.  However, the internet has given rise to a new form of personal loans—social lending.

Social lending is a form of unsecured personal loan.  However, instead of getting the loan from a lending institution, you are getting it from an individual who wants to loan you their money in return for gains earned from interest.  So yes, you will have to pay interest on any loans borrowed from social lending sites.  However, the rates are often a lot more favorable than personal loans through banks. LendingClub.com, a social lending site, touts that their interest rates for personal loans start at just 6.78% for a person with excellent credit.  The rates at Prosper.com (another top social lending site) start at 7.4%.  Overall, the loan rate for debt consolidation from social lending sites is almost always going to be lower than the rate that a bank will charge you for a personal loan.  However, to be sure, you should apply to both a bank and a social lender.

Balance Transfers

Another source for credit card debt consolidation is obtaining 0% interest credit cards for a balance transfer.  A balance transfer is a way for you to move your high interest credit card balance onto a card with lower interest.  Many credit card issuers offer 0% interest rate on balance transfers.   You should be careful though as the 0% interest only lasts for a fixed amount of time, usually a year, your interest rate hikes to the standard rate.  Use that 0% interest to your advantage and pay off your balance before the interest rate resets to the card’s standard rate.  

As a caveat, balance transfer always have a fee attached to the balance transfer so you should always find out how much the fee is to transfer your balance.  For instance the balance transfer fee of Citibank is 3% of the balance transfer.  Many other banks charge the same amount for a balance transfer.

The Dangers of Loan Consolidation

Loan consolidation can be your savior if done right.  But if done wrong, it can lead you to further financial ruins.  The danger in debt consolidation comes in when people don’t use it as a tool to work down their debt but instead pile on more debt.  A perfect example of this is when someone gets a personal loan to pay off their credit cards but then they end up using their credit cards again just weeks later.  So now that person is having to pay for both the personal loan and any new credit card debt a person accrues.  This is a pitfall in loan consolidation; just because you paid off your old debt doesn’t mean you are free.  The loan consolidation process just gives you lower payments and a longer timeline to pay off your debt.

Is Debt Consolidation Right For You?

Debt consolidation is not always the right way to go.  It has to always depend on the terms and your current living situation.  For instance, if you owe $10,000 of debt at 9.99% interest—is it really worth it to get a personal loan that gives you 5 years to pay off the $10,000 but at an interest rate of 19.99%?  In the end getting out of debt is all about having the right debt management plan and sticking to it.

If you want to find out if a debt consolidation is right for you, use this wonderful debt consolidation calculator made by Bankrate.com.