Home > Managing Debt > When Is Debt Consolidation Legitimate?

Comments 4 Comments

Does the phrase “debt consolidation” mean anything to you? For some, it brings to mind the idea of financial scams and disreputable companies trying to take advantage of unsuspecting consumers.

But is that really the case?

Well, yes and no. Debt consolidation, at its most basic level, is simply the action of grouping all your debt into one combined debt. For example, say you have three student loans and decide to use debt consolidation to combine all three into one larger consolidation loan. In that case, the new loan would have a balance equal to the sum of the other loans.

Sounds pretty simple, right? Unfortunately it gets complicated by the fact that certain companies advertise themselves as “Debt Consolidation Providers” when in reality they actually do something called debt management, which is different.

Why do they call themselves something that they’re not? Because they know people are out there looking for debt consolidation loans and they believe people won’t recognize the difference between debt consolidation and debt management.

The reality is that debt consolidation is a legitimate tactic for managing your debt — but only under the right circumstances. Here’s what you need to know before diving into debt consolidation:

How Does Debt Consolidation Work?

As we mentioned above, the idea is pretty simple, but it turns out there are a variety of ways you can actually do debt consolidation, and each one has specific advantages and disadvantages. Here is a quick overview of the types of debt consolidation programs:

1. Standard debt consolidation loan: This requires you to get a loan from a bank, credit union, or peer-to-peer lender who will agree to consolidate all your debts (usually credit card balances) into one new loan. The benefit to you is that the interest rate on the consolidation loan is often lower than what you were paying before.

2. Balance transfer offers: Technically, a credit card balance transfer is a type of debt consolidation, because it involves consolidating all your credit card debt onto one new card. Often, you will see 0% interest periods of 12-18 months on a balance transfer offer, which can really help if you are sure of your ability to pay off your balance during that time. If you don’t pay off the entire balance before the introductory period expires, you may accumulate steep interest charges.

3. Home Equity Loan or HELOC: While this is only an option for people who already have a mortgage, it is one that many Americans have been using in recent years. A home equity loan means that you are borrowing against the value of your home to pay off your credit cards (or other debts). The home equity loan will charge less interest but comes with the added risk that if you cannot pay it back your lender can foreclose on your home.

4. Student loan consolidation: A student loan consolidation can be slightly different from a standard consolidation loan because many times you are borrowing from the federal government. Usually, the government offers low interest rates and flexible repayment schedules. But keep in mind that student loan debt is much harder to discharge through bankruptcy than other types of debt, and the government can sometimes garnish your wages if you default on your federal student loans.

How Can You Find a Reputable Debt Consolidation Company?

So what should you do if you’d like to pursue a standard debt consolidation loan? You’ll need to prepare yourself to identify a reputable debt consolidation company. First, try contacting your local credit unions and banks and ask them what interest rates they can offer you. Then compare and see which ones offer the most attractive deal. You can also research companies like Lending Club that offer peer-to-peer loans. According to Gerri Detweiler Credit.com’s consumer credit expert, “true debt consolidation loans can be hard to find. The more debt you have, the harder it is to qualify for a new loan. But some lenders, especially social lending firms and credit unions for example, offer consolidation loans at reasonable rates.”

As you do your research, watch out for any company that tries to sell you something other than debt consolidation, is pushy, or makes you feel uncomfortable in any way. Don’t get hoodwinked by a fast-talking salesman who convinces you that he can make your debt go away quickly or whose promises sound too good to be true.

Does Debt Consolidation Hurt Your Credit Score?

If you’re interested in debt consolidation, it’s very important to determine how it will impact your credit score. And in order to tell whether debt consolidation hurts your credit score you must know which type of consolidation you’re going to be doing. Applying for any type of loan usually requires a hard credit check, which can lower your score a small amount.

But more importantly, you should be aware of how your credit utilization will be affected. Credit utilization refers to the percent of your available credit that you’re currently using. For example, if the credit limit on all your credit cards combined is $30,000 and you have $15,000 in credit card debt then your credit utilization is at 50%. But if you get a debt consolidation loan and close all your credit card accounts, your total debt will still be $15,000 but your credit utilization will now be 100%, which may hurt your credit score.

According to Detweiler, “a debt consolidation loan shouldn’t hurt your credit score. You may see a dip temporarily since you have a new account. But if you pay it on time, that should even out. If you close all the credit cards you’ve consolidated you may see your scores drop – though for some that may be safer than running the risk of charging on those cards and getting deeper in debt!”

Ultimately, debt consolidation can be a good option, but it’s not something you need to rush into. If you evaluate all your options and use the information above to research whether debt consolidation is right for you, then you’ll be in the good mindset to make a wise decision.

This story is an Op/Ed contribution to Credit.com and does not represent the views of the company or its affiliates.

Image: BLW Photography, via Flickr

Comments on articles and responses to those comments are not provided or commissioned by a bank advertiser. Responses have not been reviewed, approved or otherwise endorsed by a bank advertiser. It is not a bank advertiser's responsibility to ensure all posts and/or questions are answered.

Please note that our comments are moderated, so it may take a little time before you see them on the page. Thanks for your patience.

Credit.com receives compensation for the financial products and services advertised on this site if our users apply for and sign up for any of them.

Hello, Reader!

Thanks for checking out Credit.com. We hope you find the site and the journalism we produce useful. We wanted to take some time to tell you a bit about ourselves.

Our People

The Credit.com editorial team is staffed by a team of editors and reporters, each with many years of financial reporting experience. We’ve worked for places like the New York Times, American Banker, Frontline, TheStreet.com, Business Insider, ABC News, NBC News, CNBC and many others. We also employ a few freelancers and more than 50 contributors (these are typically subject matter experts from the worlds of finance, academia, politics, business and elsewhere).

Our Reporting

We take great pains to ensure that the articles, video and graphics you see on Credit.com are thoroughly reported and fact-checked. Each story is read by two separate editors, and we adhere to the highest editorial standards. We’re not perfect, however, and if you see something that you think is wrong, please email us at editorial team [at] credit [dot] com,

The Credit.com editorial team is committed to providing our readers and viewers with sound, well-reported and understandable information designed to inform and empower. We won’t tell you what to do. We will, however, do our best to explain the consequences of various actions, thereby arming you with the information you need to make decisions that are in your best interests. We also write about things relating to money and finance we think are interesting and want to share.

In addition to appearing on Credit.com, our articles are syndicated to dozens of other news sites. We have more than 100 partners, including MSN, ABC News, CBS News, Yahoo, Marketwatch, Scripps, Money Magazine and many others. This network operates similarly to the Associated Press or Reuters, except we focus almost exclusively on issues relating to personal finance. These are not advertorial or paid placements, rather we provide these articles to our partners in most cases for free. These relationships create more awareness of Credit.com in general and they result in more traffic to us as well.

Our Business Model

Credit.com’s journalism is largely supported by an e-commerce business model. Rather than rely on revenue from display ad impressions, Credit.com maintains a financial marketplace separate from its editorial pages. When someone navigates to those pages, and applies for a credit card, for example, Credit.com will get paid what is essentially a finder’s fee if that person ends up getting the card. That doesn’t mean, however, that our editorial decisions are informed by the products available in our marketplace. The editorial team chooses what to write about and how to write about it independently of the decisions and priorities of the business side of the company. In fact, we maintain a strict and important firewall between the editorial and business departments. Our mission as journalists is to serve the reader, not the advertiser. In that sense, we are no different from any other news organization that is supported by ad revenue.

Visitors to Credit.com are also able to register for a free Credit.com account, which gives them access to a tool called The Credit Report Card. This tool provides users with two free credit scores and a breakdown of the information in their Experian credit report, updated twice monthly. Again, this tool is entirely free, and we mention that frequently in our articles, because we think that it’s a good thing for users to have access to data like this. Separate from its educational value, there is also a business angle to the Credit Report Card. Registered users can be matched with products and services for which they are most likely to qualify. In other words, if you register and you find that your credit is less than stellar, Credit.com won’t recommend a high-end platinum credit card that requires an excellent credit score You’d likely get rejected, and that’s no good for you or Credit.com. You’d be no closer to getting a product you need, there’d be a wasted inquiry on your credit report, and Credit.com wouldn’t get paid. These are essentially what are commonly referred to as "targeted ads" in the world of the Internet. Despite all of this, however, even if you never apply for any product, the Credit Report Card will remain free, and none of this will impact how the editorial team reports on credit and credit scores.

Your Stories

Lastly, much of what we do is informed by our own experiences as well as the experiences of our readers. We want to tell your stories if you’re interested in sharing them. Please email us at story ideas [at] credit [dot] com with ideas or visit us on Facebook or Twitter.

Thanks for stopping by.

- The Credit.com Editorial Team