What Is a Debt Consolidation Loan and How Can You Get One?

According to the Federal Reserve, consumer debt in the United States in the second quarter of 2021 totaled more than $4.2 billion. So if you’re struggling with debt, you’re definitely not alone. If you’re looking for a way to dig yourself out of debt, a debt consolidation loan could help.

But what is a debt consolidation loan? Find out if it’s the right option for you by learning more about it, including pros and cons. You’ll also find information about other alternatives.

In This Piece

• What is debt consolidation?
• Pros and cons of debt consolidation loans
• Alternatives to debt consolidation loans

What Is Debt Consolidation?

Debt consolidation occurs when you bring multiple existing debts under a single umbrella. This usually means you use some type of credit or other financial tool to convert multiple debts into a single debt. Debt consolidation loans are one of the most popular ways to consolidate debt.

What Is a Debt Consolidation Loan?

A debt consolidation loan consolidates, or combines, your various debts under a single account.

Pros of Debt Consolidation Loans	Cons of Debt Consolidation Loans
Potentially lower interest rates, especially if you now have the credit score to consolidate high-interest loans under better terms	May require good credit to obtain or get a good rate
A single payment, making it easier to manage your finances	Might leave paid-off credit card and other revolving accounts open, creating an opportunity to run up even more debt than you started with
Your debt possibly spreading out over a greater amount of time, making each monthly payment more affordable	Could potentially temporarily impact your credit score if it involves closing a lot of other accounts

 

What’s the Difference Between Debt Consolidation and a Personal Loan?

A personal loan is an unsecured loan that you can use for just about anything. In some cases, you could use the funds from a personal loan to consolidate some debts, making it a debt consolidation loan.

However, a loan specifically for the purpose of debt consolidation may be handled a bit differently. For example, in some cases, the lender may not pay the money directly to you. They might pay off your debts directly instead.

Alternatives to Debt Consolidation Loans

Your options depend on your credit, existing assets, and how much debt you want to consolidate. Some alternatives to debt consolidation loans are highlighted below.

1. Refinance Your Mortgage If You Have Equity

If you have equity in your home, you can refinance it or take out a home equity line of credit, or HELOC. These options give you cash you can use to pay down debt.

Pros of Refinancing a Mortgage to Consolidate Debt	Cons of Refinancing a Mortgage to Consolidate Debt
Home equity loans and HELOCs tend to have much lower interest rates than personal loans and credit cards	You use your home as collateral for the debt, which means if you don’t pay it, the lender has a claim on your house
You may be able to deduct interest on home loans to reduce tax burdens	Variable-rate loans could come with increased interest in the future
The total number of payments you need to manage each month is substantially reduced	Credit cards you pay off could be run up again, leaving you with more debt than you started with
You’re less likely to forget to pay a debt related to your home

Tip: Don’t pocket the money that refinancing frees up every month. Instead, use it to create an emergency fund. Once that’s set up, use the money as prepayment against your home loan or to boost retirement savings.

2. Use a Balance Transfer Card

Apply for a balance transfer card if your credit is in good shape, or call a card provider to ask if they’d be interested in offering you a balance transfer option on an existing card. This lets you transfer higher-interest credit card debt to a card with lower interest rates. Some balance transfer cards offer 0% APR for six to eighteen months on balance transfers for new account holders.

Pros of Balance Transfer Cards for Debt Consolidation	Cons of Balance Transfer Cards for Debt Consolidation
Can substantially reduce the cost of credit card debt	Balance transfers usually come with fees of 3% to 5%—still less than your typical interest costs might be on high-interest credit card debt, but something to keep in mind
Makes it easier to pay off credit card debt	It can be tempting to use your old credit cards again, running up more debt and ending up with double the debt you started with
Might let you consolidate multiple cards into a single account for easier management	If you don’t pay off the debt in the introductory period, you could end up with expensive interest fees

Tip: Keep your old credit card accounts open for extra benefits to your credit score. It helps your credit utilization rates and credit age. But avoid using those accounts unless you have the money to pay them immediately.

3. Borrow from Retirement Savings

If you have retirement savings, you might be able to borrow from it to pay off debt. Remember, though, that you’ll need that money later. Only consider this option if you can pay back the money quickly so you don’t lose time building your retirement funds.

Pros of Borrowing From Retirement Savings for Debt Consolidation	Cons of Borrowing From Retirement Savings for Debt Consolidation
Doesn’t require a credit check, so you don’t need a healthy credit file	You might owe taxes and penalties on the money if you withdraw early from your retirement
Interest rates are low, and you’re actually paying it back to your own account	You can borrow against some employer-sponsored retirement plans, but debt consolidation might not be an allowed reason
	You could reduce how much money you have in retirement, especially if you can’t pay back the money

Tip: Consider this option as a last resort loan or if you have some money coming in soon, such as from a tax return. If you can pay the money back within a month or two, you don’t have as much to lose.

4. Ask a Friend or Relative for a Loan

If you know someone who has some extra money, it might be worth asking them for a loan at a low interest rate. You can use the money to pay off your debts and make one monthly payment to the person in question.

Pros of Asking Someone for a Loan for Debt Consolidation	Cons of Asking Someone for a Loan for Debt Consolidation
No credit check or requirements	If you blow it, you might ruin an important relationship
Your family member or friend can earn some interest	The IRS can be a real pain when it comes to family loans, so consult a tax professional
	Loan payments won’t be reported to your credit reports or potentially help your score

Tip: Treat the transaction as you would with a bank or other lender. Put everything in writing, agree to fees or penalties if you miss payments, and strive to make timely payments.

5. Try Debt Counseling

Debt or credit counseling with a reputable organization can help you create a viable personal budget and potentially negotiate with creditors for better terms. Debt counselors may help you understand how to better manage your income and expenses and leverage debt payoff strategies to get out from under your debt.

Pros of Debt Counseling	Cons of Debt Counseling
Can provide you with some tools to better manage debt	May not reduce the overall cost of your debt
May help you see solutions that you didn’t see before	May rely on you making personal sacrifices in your budget
Helps you pay off debt with your own resources, which can be satisfying	If you don’t work with a reputable organization, you might be scammed out of large fees with promises that the company can’t keep

Tip: Don’t work with debt counseling companies that offer 100% guarantees to reduce or wipe out your debt or that charge excessive fees. These are red flags that could point to scams.

6. Enter a Creditor Assistance Program

Many creditors have assistance programs to help account holders who are experiencing financial distress due to sudden loss of income or an emergency. These programs range from mortgage modifications, which might reduce your interest rate or total monthly payment, to skipping a single payment and having it added onto the end of the loan penalty-free.

Pros of Creditor Assistance Program	Cons of Creditor Assistance Programs
May not require good credit, especially if you have a solid payment history with the creditor	Aren’t always available
Could offer a fast, convenient solution to short-term cashflow issues	You can typically only take advantage of these tools once or once every so often

Tip: Anytime you’re experiencing financial distress or might be late with a payment, don’t ignore the issue. Call your creditor to find out what they might be able to do to help.

7. Bankruptcy

Bankruptcy is a last-resort option that can help you discharge or restructure your debts and make a new start in a few years.

Pros of Bankruptcy	Cons of Bankruptcy
If successful, you can have all or many of your debts discharged	Bankruptcy can be a long and stressful process
You may be able to keep certain assets, such as your home or car	It can dramatically impact your credit in the short term
Filing for bankruptcy establishes an automatic stay, so creditors can’t continue to attempt to collect or foreclose unless the bankruptcy is dismissed	Depending on what type of bankruptcy you file, you may not be able to get credit for a while

Tip: Talk to a bankruptcy attorney about this option before you take action. Most provide free consultations to help you understand if bankruptcy is a good choice for you.

The Bottom Line on Debt Consolidation

If you’re struggling with debt, you’re not alone. And you do have options. Look into a debt consolidation loan or one of the options above to start working on financial stability for the future.

 

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