Types of Debt Consolidation – Get Out of Debt Faster
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There are various debt consolidation options available to individuals and families in need of financial relief. This can include programs that combine multiple individual debts into one larger loan and debt reduction plans that target specific types of debt, such as credit card debt and medical bills. This can help simplify the repayment period and allow the debtor to avoid making multiple loan payments each month. Borrowers can choose the best type of debt consolidation program based on their needs and financial situation.
Debt consolidation has become a popular way to get out of debt. When you consolidate your debts, you merge all of your debts into one monthly payment. This can make managing your finances easier and help you save money on interest payments. There are several types of debt consolidation, each with its own benefits and drawbacks.
Related: Debt Consolidation for Bad Credit
In this article
Types of debt consolidation
Debt consolidation loans
A debt consolidation loan is the most used type of debt consolidation, and it is also perhaps the easiest way to simplify your debt situation. A debt consolidation loan is a type of personal loan used to pay off multiple debts. Here's how it works: You take out a loan based on how much debt you owe, then use the loan funds to repay all your debts. This makes it easy to keep track of your finances, and you now only have to worry about a single monthly payment instead of multiple debt payments. Debt consolidation loans typically have lower interest rates than the interest rate on your debts.
However, debt consolidation loans can have origination fees and may require collateral if you have bad credit.
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Balance transfer credit cards
This one is more suited to credit card debt. A balance transfer credit card lets you transfer the balances of the high-interest debt associated with your credit cards to a new card, ideally with a lower interest rate, resulting in a lower monthly payment. Several financial institutions offer balance transfer cards with introductory 0% APR for a specific time frame. A balance transfer credit card works just like a debt consolidation loan, albeit only for credit cards. Instead of worrying about debt on multiple credit cards, you can now focus better on repaying debt on just one card.
Credit card balance transfers can help you save money on interest payments, but they typically come with a relatively high balance transfer fee.
Home equity loans
A home equity loan is a type of secured loan that uses your home as collateral. Home equity loans come in two forms:
- Home equity loan: This is like a run-of-the-mill loan. You're given a lump sum and you can choose to spend it as you please, which in this case in toward repaying debt.
- Home equity line of credit: Instead of a lump sum, the lender opens a line of credit for a specific sum. For example, you've been approved for a line of credit of $50,000. Instead of taking the whole sum in one go, you can choose to take from it as you please. And you will only have to repay the money you take from the credit line, not the whole amount you were approved for.
Home equity loans typically have lower interest rates than unsecured debt like a personal loan, but they can be difficult to qualify for if you have bad credit. On top of that, if you default on the loan, the creditor may foreclose on your home to recoup its costs. Before you go down this road, you have to be sure you can make the payments on time, because otherwise, you risk losing the roof over your head.
Student loan consolidation
Yes, your student loans can be consolidated as well, and this isn't just limited to federal loans (although that does make things easy). If you have a private student loan, the lender can repay your federal or private loan on your behalf. It will then issue you a new loan, hopefully at better repayment terms, such as a low-interest rate and a more favorable repayment schedule. The Federal Direct Loan Program allows you to consolidate your loans into a direct consolidation loan if you have federal student loans. As for the interest rate, you can expect to pay whatever the weighted average of your previous loans comes out to be.
You shouldn't refinance your student loan if it's still in the grace period. Once that is over, however, you can go ahead with the refinancing.
Alternatives to debt consolidation
Not sure if debt consolidation is right for you? Here are other options you can consider.
Debt settlement
Debt settlement is a process where you negotiate with your creditors to settle your debts for less than the full amount. But why would the creditor be open to such an arrangement? It's because they know you're in a financial pinch and have been unable to make payments on time. From the lenders' perspective, they see debt settlement as a means to recoup at least the principal amount, i.e., without the interest.
If you're unsure how to go about initiating a discussion, you can enlist the services of a debt settlement company. These companies specialize in debt settlement negotiations, and while the consultation is free, you'll be charged a portion of the amount these companies help you save. Members typically graduate from these programs in two to five years. Eligibility-wise, these companies only extend this debt relief option to people with loans that aren't secured. Such types of loans include credit cards or unsecured personal loans.
Debt settlement can be risky and can damage your credit score initially.
Credit counseling
Creating a budget isn't for everyone, and the situation can get aggravated if you're juggling different types of debt. That's where credit counseling comes in. Credit counseling is a process where you work with a credit counselor to create a budget and develop a plan to get out of debt. They will ask you a series of questions to better understand your financial situation. Once you've provided the requisite information, they will devise a debt management plan for you to become debt free.
Bankruptcy
Chapter 7 and Chapter 13 of the U.S. Bankruptcy Code is reserved for people, but they're a little different in their workings.
- Chapter 7: This one is reserved for people who make less than $50,000 in a year. Creditors cannot make any collection efforts during the stay period, and at the end, you may see a portion or all of your debts discharged.
- Chapter 13: Also called a "wage earner's plan," this type of bankruptcy is for individuals who fall into higher income brackets. The catch? Your debts aren't discharged. Instead, the debtors and creditors agree on a repayment plan that lasts three to five years.
But bankruptcy's effects on your credit report remain for years (10 years, to be exact). You can expect your credit score to fall substantially after you've filed for bankruptcy. But rebuilding your credit after bankruptcy isn't outside the realm of possibility. Keeping your credit utilization ratio and making timely payments on existing debt will go a long way.
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Debt consolidation and credit scores
If you're considering consolidating your debts, it's important to understand how it will impact your credit score. In general, debt consolidation can help improve your credit score if you make your payments on time and don't increase your debt. However, under some circumstances, your credit score might take a hit too. For example, if you miss payments or default on the loan, you will damage your credit score.
If you're unsure if debt consolidation is right for you, consider alternatives such as debt settlement or credit counseling. No matter what route you choose, getting out of debt is a process that takes time and patience. But with the right information and support, it is possible to get out of debt and rebuild your credit score.
Debt repayment isn't easy especially if you have different kinds of debt at higher interest rates. If you're struggling with debt, contact a nonprofit credit counseling agency today to get started on your journey to financial freedom.
Pros and cons of debt consolidation
Pros
- Can help you save money on interest payments: Debt consolidation can help you save money on interest payments. When you consolidate your debts, you can often get a lower interest rate. This can help you save money over time.
- Can make it easier to manage your finances: When you consolidate your debts, you have one monthly payment instead of several. This can make it easier to keep track of your finances and budget.
- May improve your credit score: If you make your payments on time and don't increase your debt, consolidating your debts can help improve your credit score.
Cons
- Can have fees and charges: Some types of debt consolidation come with fees and charges. For example, balance transfer credit cards typically have a fee for transferring your balance.
- May not be an option if you have bad credit: If you have bad credit, some types of debt consolidation may not be an option. Home equity loans, for example, typically require good credit.
- Has the potential to damage your credit score: If you miss payments or default on a loan, consolidating your debts can damage your credit score.
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- Subject to qualification and approval. $1,500 monthly income required.
- Apply in 5 minutes. If you qualify, chat online with a friendly online debt representative.
The bottom line
Which type of debt consolidation is right for you? That depends on your financial situation and goals. A home equity loan may not be an option if you have bad credit. A balance transfer credit card may be the best option if you're looking to save money on interest payments. A debt management program may be the right choice if you're struggling to make your monthly payments.
There are many different types of debt consolidation, and each has its own pros and cons. It's important to understand how each type of consolidation will impact your credit score before you make a decision. In general, debt consolidation can help improve your credit score if you make your payments on time and don't increase your debt. No matter which type of debt consolidation you choose, make sure you do your research and compare different options before you decide on a plan. This will help ensure that you choose the right option for your needs and avoid potential pitfalls.
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Writer
Jasir Jawaid is Joy Wallet's Assistant Editor. He has more than 13 years of experience as a journalist covering Wall Street, equities, financial policy and regulation, and cryptocurrency and blockchain.
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