We get lots of questions about debt consolidation at Credit.com, and that's because there are so many ways to consolidate debt. Let's start with the basics: debt consolidation refers to the act of grouping all your different debts into one single debt.
For example, say you have three credit cards 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.
There are a few ways to consolidate your loans. You've probably heard of credit card balance transfers, but another option is a personal loan. They require you to get a loan from a bank, credit union, or peer-to-peer lender who will agree to consolidate some or all of your debts (usually credit card balances) into one new loan.
If the interest rate on this new personal loan is lower than the interest rates on the different credit cards that you are consolidating, you'll save money. In addition, you'll have a fixed payment schedule that requires you to pay back the debt in 2 - 5 years (depending on the terms of the loan). That can help you avoid the minimum payment trap that can keep you in debt for years to come.
Sometimes what appears to be debt consolidation isn't. For example, a debt management program (DMP) through a credit counseling agency allows you to make one monthly payment to the counseling agency, and in turn, the agency pays all of your participating creditors. However, the agency doesn't pay off your debts, so it's not a true consolidation loan, even though it may have the same effect as one.
What is Peer-to-Peer Lending?
Peer-to-peer lending, otherwise known as P2P, is a different way of borrowing money that does not use the services of a traditional bank or credit union. Instead, the loans are made by investors or other individuals. If you have good credit, you can often find that borrowing using P2P lending may be a great alternative to traditional loans.
With a P2P loan, you can typically borrow the funds with lower rates than you would find at the bank. However, you may have to pay a bit more in interest to keep the investor on your good side. With this kind of lending, you also don’t need to worry about any overhead or other costs and hidden fees.
It also makes shopping around for a loan much easier and typically it will only take a few days to find out if you are approved for the loan or not. Debt consolidation with P2P lending awards the borrower with reasonable interest rates, flexibility to pay off the debt, and higher chances of approval- even with not-so-perfect credit.
Credit Card Balance Transfer
When you use credit card balance transfers for debt consolidation, you are basically shifting the total debt from several of your cards to just one that has a much lower interest rate. It can be a viable way to help pay down your debt and even save some money in the process.
However, this is only a good debt consolidation plan if you can find a credit card with that lower interest rate and a minimal or nonexistent balance transfer fee. The credit limit also has to be high enough to accommodate the debt you have incurred on the other credit cards.
Obtaining a personal loan from a bank or credit union is another common way to consolidate debt. Credit unions are ideal because they offer more in the way of flexibility, lower fees, and more member-focused service. You will also have a chance at getting approved for a personal loan through a credit union even if you have poor credit. Your chances are greater than they would be at a bank.
When getting a personal loan to consolidate your debt, make sure you consider the interest fees and make sure you can comfortably make the monthly payment for the duration of the repayment plan.
Tips for Getting Approved for a Debt Consolidation Loan
To get approved for a debt consolidation loan, you will want to first decide on the loan type you want and whether it is an unsecured or secured loan. A secured loan requires collateral, but an unsecured loan (like a credit card) does not.
You will then need to figure out approximately how much money you will need to borrow to cover the total of all of your debt payments. Once you have this information, check your credit score and credit history to see where you stand so you can find the right lender.
Make a checklist of what you want and need concerning interest rates, monthly payments, and other repayment options and you can then discuss the loan options and financial situation with the bank, credit union, or financial institution you will be going with.
Finally, the debt consolidation does not stop with the loan payments and paying off the debt. You will want to take a closer look at your spending habits and see where you can save and what you need to change to be able to avoid building the debt back up.
Coming up with a debt management plan is the best first step to take after considering debt consolidation.
Disclaimer: The person depicted is a model accompanied by a testimonial for illustrative purposes only.