Debt Consolidation Companies: Legit Helpers or More Pain Than Gain?

When you are swimming in debt - particularly credit card debt that may have gotten out of control through tough times, say a health emergency where medical bills have piled up, a job loss where you blew through any savings you may have had, or even a global pandemic - you may find yourself wondering how you'll ever be able to catch up.
This is when you start to notice debt consolidation and debt settlement companies. These companies either offer you programs that can help you consolidate your debts into a single loan payment or even work with your debtors to offer lower payments to your credit card and loan companies to settle and close accounts.
While we do not recommend using a debt settlement company, we'll examine debt consolidation companies in this article. While they can be a great relief if you’re facing financial hardship, there are also cases where getting involved with one of these companies or organizations can be more headache than it’s worth. If debt consolidation is something that you’re considering, you must understand what to look for to avoid getting scammed or misled.

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Types of debt consolidation

One of the most important things to understand is that "debt consolidation" tends to get thrown around loosely. For example, someone could be saying “debt consolidation” when referring to a debt consolidation program, or they could be saying it about a debt consolidation loan.

Debt consolidation program

A debt consolidation program is a service that a company or organization might offer to help you manage your debts, including credit card debt. Most companies that offer debt consolidation programs are nonprofit credit counseling agencies, but for-profit companies provide this service.
You can request a meeting with one of these companies or agencies to discuss your debt and personal finances. These meetings are usually informational, so you can explain your situation and see if the company can help you. The meeting also allows you to ask about the process, what the organization does, and the fees.
There is often a misconception that because some of the organizations that offer debt consolidation programs are nonprofits, the services will be free. This is not necessarily true. If the company or organization does charge a fee for the program, you should expect them to be upfront about that. It’s not unusual for these organizations to charge monthly fees in addition to a setup fee.
After learning about your debt, some of the less reputable companies may offer a debt settlement program. These programs are unfavorable on your credit reports and an unofficial bankruptcy in a way. Avoid these!

Debt consolidation loan

A debt consolidation loan means that you’re taking out a new loan intending to use it to pay off your existing debts. When you take out a debt consolidation loan, you typically take out a large enough loan to cover all of your debts. Once you receive the money, you use it to pay off all of your current loans. Then you’ll make monthly payments on the debt consolidation loan instead of making multiple monthly payments for all of the other loans.
Debt consolidation companies tend to offer these loans, but you may also be able to get a debt consolidation loan through your bank.
You can also get specific debt consolidation loans, such as student loan consolidation loans, home equity loans, and cash-out mortgage refinance loans.
Credit cards sometimes offer credit card consolidation by providing you an account balance high enough to take on your other debt and then allowing you to transfer your debt from one or more credit cards into the new card. These are balance transfer credit cards.

The costs of debt consolidation

Debt consolidation can sound appealing to many people trying to become debt-free or get out of debt faster. However, you have to consider the situation that could lead you to need to consolidate your debts. In most cases, if you’re looking to reduce, it means that you may be facing financial hardship. The tricky thing about debt consolidation is that it could add more costs to your plate when you’re already struggling.
Before you agree to any debt consolidation program or loan, you must carefully research the company and the service or product. Don’t be afraid to ask questions and walk away from a company or organization if you don’t have a good feeling about it. You should expect any organization you work with to be open and honest with you about how it works and the costs. If your questions are avoided or evaded, you may want to look for a different organization.

Service fees

You should also be mindful of the amount that you’re asked to pay for debt consolidation services. Even if a company is for-profit, the fees should be reasonable. Of course, reasonable fees vary by state, which is why it’s so important to check with your local consumer protection agency about any organization that you’re considering. You may be able to get some guidance on what a reasonable fee is either from this agency or your state’s Attorney General’s office.

Interest rates

If you’re considering a debt consolidation loan, be sure to understand exactly what costs are involved in your new loan. If the interest rates are higher than you’re paying with your current loans, taking out the new loan could put you in an even more difficult financial situation in the long run. You should compare loan rates across various companies (as well as loan terms) to see which offers the lowest fees and interest rates before you make your decision on which company to use.
You may want to enroll in a fixed-rate loan to guarantee that your monthly interest doesn't increase over the time you repay the loan.
The same is true of credit card consolidation: You obviously will want the lower interest rate based on your eligibility to pay off your high-interest credit cards. Still, these can be higher than loans from debt relief companies.

Other fees

You'll also want to check the late payment fees in the event you still have trouble paying. These can add up quickly.
If you suspect consolidation will free up funds to allow you to pay off the debt faster, be aware of any prepayment penalties. Some debt consolidation loans make money based on your monthly payments and charge higher fees if you leave the program early.

Credit number

Other costs come with debt consolidation, including a hit to your credit. To apply for a new loan or credit card, your credit history will be pulled, and this credit check will be reported to the credit bureaus and will cause your FICO Score to drop. You do not want to do this more than once in your attempts to find a consolidation program. If you already have bad credit because you cannot make payments, you may not mind this, knowing you'll begin rebuilding your credit as soon as you are consolidated.

Best debt consolidation companies

It's essential to do your due diligence before you sign up for any debt consolidation program or loan. The Federal Trade Commission recommends that you check with your local consumer protection agency and your state’s Attorney General before you do any business with a debt consolidation service as there are many debt consolidation scams out there. You’ll want to know if there are any consumer complaints on file about the company or organization you’re considering working with. You can also ask your state Attorney General’s office if the company or organization is required to be licensed to do business in your state. They will also be able to tell you whether that company or organization is licensed or not.

The National Foundation for Credit Counseling

The NFCC is a nonprofit organization with a national network of nonprofit member agencies. At each agency, you’ll find NFCC certified financial counselors on staff to help you analyze your finances. The counselors will conduct a financial review, then help you establish a budget and provide you with a personalized economic action plan to follow.
The NFCC offers a debt management plan as part of its services. If you’re eligible for the program, your certified financial counselor will set up a voluntary agreement between you and your creditors. Then you’ll make one payment each month to your agency, and the agency will send payments from that to your creditors. These payments are typical $25, but you will pay a set-up fee of up to $50.
The benefits of the NFCC’s debt management program may include reduced or waived finance charges or fees. You’ll also benefit from having a set monthly payment that is most likely lower than the payments you were making individually to your different creditors. Once you’ve finished paying off your debts, you may also see an increase in your credit score.

Discover

Discover is a familiar name to many, and it can be a surprise to learn that in addition to credit cards and online banking, it offers debt consolidation loans. Discover offers a few different debt consolidation options for you to choose from.
One way that you can consolidate your loans with Discover is by doing a balance transfer. In some cases, you may be able to transfer your balances to a credit card that has a 0% introductory APR offer. Typically, this offer will charge 0% interest for the first 12 months after opening your credit card account. This helps you move high-interest debt to a new card, where you may have a better chance of paying down the debt because you are no longer paying interest.
Discover also offers personal loans, which you can use to consolidate your debt. You can use your new personal loan to pay off your debts. Discover’s personal loans allow you to lock in a fixed interest rate so you know what you’ll be paying in interest right from the start. It also has no origination fees and does not require any collateral.
If you have student loans that you want to consolidate, you can also do that with Discover. Discover allows you to refinance both your federal and private student loans into a single loan. You can choose between a fixed or variable interest rate and pick from flexible repayment terms that could help lower your monthly student loan payment.
Additionally, Discover offers home equity and mortgage refinance loans.

LendingClub

A peer-to-peer lending company, LendingClub provides loan offers to those with fair credit – up to $40,000 in an unsecured loan. However, it is only available to those with a minimum credit score of 660 or above, which means you may not qualify without a co-signer.
But for qualifying applicants, the fees are low: a one-time loan origination fee (3 to 6% of your loan amount) and no prepayment penalties, loan application fees, or broker fees. You will be charged late payment fees if you fail to make a payment within 15 days of the due date.

Upstart

Another personal loan option is Upstart, which allows you to get approved online quickly. You can sample what your interest rates will be without affecting your credit score. Loans are available for up to $50,000 with three- or five-year repayment terms at fixed rates, the lowest rates at 7.86%.
Upstart can fund you as fast as the next business day after you accept the loan offer and touts its debt consolidation loan rates are 16% lower than traditional models. You cannot consolidate student loan debts in these loans. If you have taken out a payday loan, you can include these in the program.

Pros and cons of debt consolidation options

Debt consolidation program pros and cons

Pros
  • Your loans will stay right where they are now. You won’t need to deal with getting a new loan or transferring debts.
  • Credit score is not impacted. In most cases, your credit score will not be affected by enrolling in a debt consolidation program.
  • You may be able to reduce your interest rate and your monthly payments. In addition to helping you pay off your debts, you’ll receive counseling that may be able to help you manage your finances better in the future.
Cons
  • Only unsecured debts are eligible for debt consolidation programs. If your loan is secured by collateral (such as a home or auto loan) it is most likely not eligible for the program. In some cases, you may have to agree not to take out new loans while you’re paying off your old debts.
  • No credit lines. You may also be asked to close some of your credit cards if you participate in a debt consolidation program.

Debt consolidation loan pros and cons

Pros
  • Allows you to pay off your pre-existing debts with a lump sum. If you’ve fallen behind on your debt payments, using a debt consolidation loan to pay those debts off can help you avoid paying repeated penalties and late fees.
  • Possible 0 interest. Some debt consolidation loan options — such as balance transfers — may offer no-interest introductory offers.
Cons
  • Debt consolidation loans typically come with higher interest rates. So even though you’re paying off all of your other loans, you may end up paying more in the long run due to the higher interest rate. If you use a home equity loan, you have to be very mindful of staying on top of your loan payments, or else you might jeopardize your homeownership.
  • Temptation exists. The lender of your debt consolidation loan isn’t going to require that you close your credit cards or accounts. This means that the temptation to use those cards will still be there, and it can be very easy to end up deep in debt once again.
  • No counseling. There is usually no financial counseling aspect of debt consolidation loans. Even though you’re solving the problem in the short term, you won’t be getting any support to help you address the larger issue that may be at hand.
  • Since you’re taking out a new loan, this can affect your credit score.

Alternatives to debt consolidation companies

There may be a safer way to consolidate your debts into a manageable program. Consider these options.

Balance transfer credit cards

If you aren't experiencing a hardship and simply want to consolidate your debt, a new credit card with a balance transfer option can help. Here, you consolidate your credit cards into one account, perhaps with lower introductory credit card interest rates that can leave you with extra money at the end of the month.

Create your own debt payoff program

Rather than hirer a company to work out a debt repayment program, do it yourself with the debt snowball method. Start by taking your smallest debt and put extra money toward paying it. Once it is paid off, take the funds you were putting toward it and add it to the monthly payment of the next smallest balance and continue on this path until you reach your largest debt - like a snowball gaining traction and size rolling downhill.
Similarly, you can tackle the debt with the highest interest rates first and work your way down to the lowest interest debt.

Dip into your emergency fund

If your financial hardship is getting too overwhelming to manage, such as unexpected medical bills, this is a time to dip into your fund. When you get steady again, you budget to get money returned to this savings account.

The bottom line

Debt consolidation is not something that you should enter into lightly. If this is something that you’re considering, there’s a lot to be mindful of. First, you’ll want to ensure that any organization or company you’re considering is reputable. You may also want to compare companies and options to be sure that you find the best debt consolidation option based on your needs.
Though it sounds straightforward, debt consolidation is not a one-size-fits-all situation. There are several ways to consolidate your debts, and each option can be a fine decision if it meets your needs. Whether you decide to enroll in a debt management program or take out a debt consolidation loan, you’ll need to consider the fees as well as the risks carefully.
However, if done right, debt consolidation can be a wonderful way to improve your credit and get on a better financial path for the future.

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