Debt Consolidation Loans: Understand Your Options

If you feel like you are constantly worrying about how to make your next payments on time, you are not alone. Around 80 percent of Americans struggle with debt. You do not have to be an extravagant spender to find yourself in this position, either.

US total household debt has skyrocketed in recent years, reaching a peak of around $14 trillion in 2020.

^{US household debt has surpassed $14 trillion in 2020. (Source: Reuters.com)}

What can you do if you find yourself burdened by financial worry? Where can you find debt relief?

Your repayment options include credit counseling, debt consolidation, debt settlement, and bankruptcy. Before making a decision about debt consolidation though, you need to know the answers to some frequently asked questions, such as:

• What is debt consolidation?
• What are some different types of debt consolidation?
• How does debt consolidation work?
• How does debt consolidation compare to other debt relief options?
• What are the pros and cons of debt consolidation?
• Who are the best candidates for debt consolidation?
• Does debt consolidation hurt your credit score?
• What are the qualifying requirements of consolidation loans?
• Is debt settlement a better option for you?

What Is Debt Consolidation?

Consolidating multiple debts is the act of rolling different types of debts into one liability.

Your first step toward consolidating your debt faster, or bringing it all under one roof, is to pay off all your existing debt balances. This includes your credit card bills, with their high-interest rates, which may vary based on due dates and attached terms and conditions. You can accomplish that by taking out a debt consolidation loan.

Why a loan, though, rather than, say, pay off one credit card debt with another? Personal finance experts generally advise against such a tactic. Why?

It's because you need to be extremely careful when choosing your loan. For a debt consolidation loan to be a good personal loan option, there are several things that must be true:

• The loan needs to give you a preferably fixed, lower interest rate.
• Excluding your mortgage payment, your total debt should not be more than 40 percent of your gross income.
• You should have a workable plan in place to avoid charging any more on the credit cards that you are consolidating.
• You should have sufficient individual or household income to cover the consolidation loan monthly payments without undue hardship.

Types of Debt Consolidation

Unless you manage to secure a loan that can save you money, the only advantage your debt consolidation can give you is that of an easy-to-remember payment schedule. As always, the devil is in the details. Haphazard moves could land you a loan with worse terms than those of the debt you are replacing.

Credit card balance transfers

A credit card debt balance transfer involves the transferring of bank balances from higher-interest credit debt into one that offers a better interest rate and benefits. Such transfers usually have a transfer fee. In some cases, to consolidate credit card debt, the company may waive this fee.

Often, a credit card balance transfer is subject to introductory interest-free periods of up to 18 months.

The pitfall is that a violation of the cardholder agreement voids the setup. That means that you may end up paying surprise interest charges and penalties.

Restrictions may apply, so pay close attention to all the numbers involved, including the APR and the transfer fees. In many cases, with transfer fees included, you may end up doing nothing more than breaking even or worse, paying more in the long run.

Unsecured loans

An unsecured loan can be the right debt consolidation option, provided you get the right terms. This personal loan does not put your home on the line. With it, you do not run the risk of foreclosure.

The better your credit report and credit score, the better your debt consolidation loan terms can be. This is why you need to be in decent financial shape for a consolidation loan to represent a real option for you.

Home Equity Loan

A home equity loan is a lump sum that the credit provider pays to the homeowner. Its amount depends on the homeowner’s equity (the current value of the home, minus any outstanding mortgage balance). The advantage of home equity loans for debt consolidation is they generally have a low-interest rate.

The disadvantage is that the loan terms might be able to be stretched over an extended period of time, meaning that this option may not be the quickest way to pay off existing debt entirely. Another disadvantage is that, because the home equity loan is secured by your home, you could jeopardize your home if you should default on your payment.

A HELOC (Home Equity Line of Credit)

Unlike a home equity loan, which has a fixed payment amount each month, a HELOC works like a credit card. The lender establishes an amount limit based on your home equity, as well as a time limit. Within these confines, you can borrow money as you need it.

If you are in good financial shape, HELOCs may represent a viable debt consolidation solution. Remember that a HELOC acts as a second mortgage and is, therefore, a secured loan. That means that you would jeopardize your home if you should default on your payment.

How Does Debt Consolidation Work?

Let's look at the following example to understand how debt consolidation works. You currently have a debt amount of $26,000 at 18% interest. If the minimum monthly payment starts at $780, it could take you 10 years to pay off and cost over $21,000 in interest. If you consolidate the debt to a loan with a 5.8% APR and pay about $500 per month, it would take you 5 years and cost about $4000 in interest.

The only thing to keep in mind is that you need to have a good credit score and a debt-to-income (DTI) ratio that is not too high to consolidate debt and qualify for a loan with a low-interest rate.

To better understand how much money you can save, use a debt consolidation calculator.

Debt Consolidation Loans vs. Debt Settlement

The Pros and Cons of Debt Consolidation

Who Should Consider Debt Consolidation Loans?

The person best suited for a debt consolidation loan is:

• In a decent financial situation, with a good credit score. If your credit score is poor, you cannot get a good deal on your loan. It makes no sense to roll your burdensome debts into an even worse single package.
• Responsible and disciplined. The best course of action is to avoid using the credit cards that you have paid off through the loan again. Some people find it helpful to put these credit cards aside in a space that is not easily accessible, leaving just one card with a low credit limit in their wallet in case of an emergency.

Do Debt Consolidation Loans Hurt Your Credit Score?

According to Nerdwallet.com, debt consolidation loans can cause a temporary dip in your credit score. This dip results from the hard inquiry on your credit that accompanies the strategy.

The long-term effect of debt consolidation on your credit score can be positive, as long as you meet the terms of the loan and maintain the discipline required to avoid using credit cards that you have consolidated.

What Are the Requirements to Qualify for Debt Consolidation Loans?

To qualify for a debt consolidation loan, you need to be in decent financial shape. What this means is that:

• You have a stable work history.
• You do not pay too much in monthly minimum debt payments. If you pay more than 50% of your income towards debt, you likely do not qualify.
• Your credit score meets the lender's requirements.
• You have decent equity to offer in the case of a secured loan.

Can a Debt Consolidation Loan Really Help You Get Out of Debt?

Under the right circumstances, it can provided you fulfill the qualifying requirements, you are disciplined, you earn a proper income, and you have your mindset on ridding yourself of debt.

Is Debt Settlement a Better Option for You?

Debt settlement can help you pay or reduce the total amount of debt you owe, while debt consolidation aims to reduce the number of your creditors and the amount of interest you pay.

With debt settlement, debt relief companies such as ClearOne Advantage negotiate with your creditor and try to find the best ways to reduce some of your balance. The results of these negotiations are often astounding. Creditors are often willing to cut balances in half, but it's not unheard of for a creditor to reduce a balance by up to 70%.

ClearOne Advantage debt settlement can be the better option for you if you do not qualify for a debt consolidation loan. If your financial situation is dire, but you still feel you can afford to make a partial payment to your creditors, you owe it to yourself to consider the benefits of debt settlement with ClearOne Advantage before taking a drastic step like bankruptcy.

ClearOne Advantage is here to help. Our Certified Debt Specialists have helped thousands of satisfied clients break free from the burden of out-of-control debt. To learn if debt settlement is the best option for you, speak with one of our Certified Debt Specialists at 888-340-4697 to get a personalized debt relief plan.