On average, Americans carry a balance of $5,247 in credit card debt (source) alone. Add in other debts, like mortgages, car loans, and student loans, and the average debt goes up to $67,900 (source). As debts continue to mount, it is little wonder than people begin to consider debt relief options like debt consolidation.If you are up to your eyeballs in debt and looking to consolidate your debts, there are some things you should know.
In this article
- 1 What is debt consolidation?
- 2 How can you improve your chances of approval for a debt consolidation loan?
- 3 How does bad credit affect your debt relief options?
- 4 How does debt consolidation affect your credit?
- 5 How does debt consolidation compare with bankruptcy?
- 6 How does debt consolidation compare with debt settlement?
- 7 What can you do if you do not qualify for debt consolidation?
What is debt consolidation?
Debt consolidation is a process in which you take out a new loan to combine your existing unsecured loans into one payment. The advantage of this is two-fold. First, because the interest rate on a debt consolidation loan may be substantially lower than the interest rates you are paying on your current debts, you can potentially save thousands of dollars over the life of the loan. Secondly, by consolidating all your payments into one payment, you may find it easier to budget and ensure you pay your bill on time every month.
If you qualify for a debt consolidation loan with a low interest rate, you can enjoy a little extra wiggle room in your finances every month, and also pay off your balance much faster than you would otherwise.
How can you improve your chances of approval for a debt consolidation loan?
Before embarking on a debt consolidation project, it is important to know your credit score. A good or excellent credit score will go a long way toward getting you the interest rate you want to see.
You can check your score with one or more of the big three credit bureaus: Experian, Transunion, and Equifax. Check your credit score for free by registering with Credit Sesame with no trial period or other gimmicks. You won’t even have to provide a credit card.
The most well-known credit score is a FICO score. It ranges from 300 to 850, with good credit being anywhere from 650 to 749 and excellent credit being 750 and above. If your FICO score is below 650, your chances of obtaining a debt consolidation loan with a good interest rate are slim.
Here are some ways to improve your credit score and make it more likely that you can get a debt consolidation loan:
1. Pay your bills on time, every time
Your payment history counts as 35 percent of your credit score. Missing just a few payments can lower your score dramatically. So, even if you can only pay the minimum amount due on your credit cards, be sure that your payment is on time.
2. Increase your income or reduce your debt
While you may have trouble reducing your debt substantially at first, even paying off one credit card bill to a zero balance can help because it will lower your debt to income ratio. Similarly, if you can pick up some extra income, that will also reduce your debt to income ratio, making it more likely that your credit score will improve.
3. Change your due dates
If you are consistently just a few days shy of paying your bills on time, you can ask your creditors to alter the due dates for you. This is especially helpful if you are only paid monthly or bi-weekly.
4. Leave old paid accounts open
While you may think that paying off a credit card account and then closing it is a good idea, it’s not. Closing an account may put a ding in your credit score. By all means, pay off an account if possible, but leave the account open when you do. Your credit score will thank you.
5. Have more than one type of debt
It looks better to lenders when you have a mix of different credit types. A combination of installment debts such as car loans and mortgages, along with revolving debt like credit cards, is a good mix.
Once your credit score is in tip top shape, getting a debt consolidation loan is much easier. Check out our unbiased personal loan reviews here to explore great loan options for debt consolidation.
How does bad credit affect your debt relief options?
You may hear advertisements from lenders offering debt consolidation loans to consumers with bad credit. While it is possible to get a loan with bad credit, the truth is that it may not be your best option.
To make debt consolidation worth your while, it is important that the debt consolidation loan have a better interest rate than the debt you already carry. When your credit is bad, the chances of finding a loan with a good interest rate are very slim. For this reason, those with poor credit may find it advantageous to consider alternative forms of debt relief.
How does debt consolidation affect your credit?
In a perfect scenario, debt consolidation can improve your credit score. Since a debt consolidation loan pays off your unsecured debt like credit cards, your credit card companies will report those accounts as paid in full. This looks good on a credit report. Additionally, if you faithfully pay your debt consolidation loan payments on time, your credit score will improve over time.
However, it is important to note that sometimes a debt consolidation loan can get you into further financial trouble. Because your monthly payment with a debt consolidation loan will be less than the combined payments you are making now, it can seem like you have less debt than you really have. If you are not careful, you can fall back into a pattern of reckless spending and end up in worse financial shape than you are in now. Then, your credit score will plummet.
How does debt consolidation compare with bankruptcy?
While the aim of both debt consolidation and bankruptcy is to get some debt relief, the two approaches are quite different and have vastly different outcomes.
With debt consolidation, you will still pay the full principal amount you owe to your creditors. That means your credit score may actually improve with repayment of a debt consolidation loan. You will not be required to liquidate any of your assets. If you are able to meet the repayment requirements, a debt consolidation loan can help you protect your credit score and get out of debt faster.
On the other hand, filing for bankruptcy provides another kind of debt relief. A Chapter 7 bankruptcy can erase more debt, but it is hard to qualify and you will have to liquidate your assets. Unlike some people may think, bankruptcy does not always eliminate all your debt either. A bankruptcy stays on your credit report for 10 years and your credit score will suffer a major hit as a result.
Chapter 13 bankruptcies allow you to keep your property and repay your debts over three to five years. However, they also stay on your credit for 10 years and do not always discharge all of your debt. Chapter 13 bankruptcies cost $2,000 to $6,000 in filing and attorney fees. Worse yet, many people find it impossible to complete the repayment plan outlined in a Chapter 13 bankruptcy, meaning that you may end up right back where you started with your debt issue – except that this time, your credit score will have taken a huge hit in the process.
How does debt consolidation compare with debt settlement?
Another option to consider is debt settlement. Debt settlement is the process by which you or a debt settlement company of your choice negotiates with your creditors to reduce the principal amount of debt you owe. A reputable debt settlement company with good experience can often get you a 30 to 50 percent reduction for your debt.
Unlike debt consolidation in which you pay the entire amount due on your current debts, debt settlement enables you to come to an agreement with your creditors to accept less than what is owed in return for canceling the rest of your debt.
While debt settlement does have a negative effect on your credit, that effect is not generally as severe as the effect of a bankruptcy proceeding. Thus, debt settlement is an attractive option to avoid the negative consequences of bankruptcy.
What can you do if you do not qualify for debt consolidation?
If you find that you do not qualify for debt consolidation or you feel that you will not be able to honor the repayment terms of a debt consolidation loan, it may be in your best financial interests to explore the option of debt settlement.
In this way, you can lower the principal balance of the debt you owe and, in many cases, get out of debt more quickly. Do you need more information about whether debt settlement is your best option? Get a free debt settlement consultation today to talk with an expert who can guide you through the options that will work best with your particular financial situation.