Bad credit scores affect more people than you may think. Roughly 77 million Americans have a debt that is at least 180 days past due (source). If you are one of them, you may struggle to find lenders who will accept your loan applications. This guide provides explains in detail what options are available to people for debt consolidation with bad credit.
If you are thinking about debt consolidation as a way to relieve some economic pressure and get your finances back in control, bad credit can be a significant impediment to finding a loan. What options do you have when your credit scores are not so great?
What is debt consolidation?
Debt consolidation is a process that allows qualified consumers to take out a new loan that pays off most or all of their outstanding debt. Combining all the individual debts into one loan simplifies your finances by providing one consolidated bill.
Ideally, a debt consolidation loan will carry a lower interest rate than you may be paying now. If you can find a loan with a much lower interest rate, you may be able to save thousands of dollars over the course of your loan. In addition to saving money, a debt consolidation loan can sometimes help people who are struggling with many bills to get a firm handle on their finances.
Unfortunately, this is not always the case. For instance, let’s suppose you qualify for a debt consolidation loan. Your new monthly payment may be less than what you have been paying to multiple creditors in the past, so there may be a temptation to increase your spending. If you do this, you might eventually find yourself in a worse spot than you are in now. Just the opposite of what you want.
Rather than focusing entirely on your monthly payment amounts, your aim should be to actually manage your total debt load.
Can people consolidate debt with bad credit?
For debt consolidation to really work like it is intended to work, the interest rate on the debt consolidation loan must be lower than the interest rate you are paying on your unsecured debt now. In other words, if you are paying a 14% interest rate on a credit card and you find a debt consolidation loan for 8%, that is good news. However, if you cannot get a debt consolidation loan at a lower rate, it may not be worth it.
Over 55% of American consumers have sub-prime credit scores, meaning that they cannot qualify for credit or financing at prime rates (source). When financial services are needed for this segment of the population, the high interest rates these consumers have to pay often keep them in an endless cycle of debt and financial distress.
The chances of being offered a good interest rate on a debt consolidation loan when you have bad credit are slim. This is why most people with bad credit may need to consider other alternatives for getting out of debt. A few of these options include consumer credit counseling, debt settlement, and bankruptcy.
What can you do to improve your chances of finding a debt consolidation loan?
Although borrowers with bad credit are unlikely to get a debt consolidation loan, there are a few things you can do to improve your chances. The first thing to do is to confirm exactly where you stand with your credit score. You can do this for free by registering with Credit Sesame. Your credit score may not be as bad as you think.
If you can delay getting a debt consolidation loan until you can take steps to improve your credit score, you may have more success in finding a loan with a good interest rate.
What options exist for debt consolidations for people with bad credit?
Common types of debt consolidation loans are:
- Secured personal loans (HELOCs and mortgage refinancing)
- Unsecured personal loans.
- Secured personal loans.
- Balance transfer credit cards.
- Home Equity Lines of Credit (HELOC).
Secured debt consolidation loans
If you own a home and it is worth more than you owe on it, you may be able to get a home equity loan or line of credit from your mortgage lender, your local bank, or a credit union. Typically, home equity loans have lower interest rates than unsecured loans. The same goes for cashback mortgage refinances.
However, if you do not own a home or if you have not built up sufficient equity in your home, this is not an option. Another thing to consider carefully with this option is whether you feel comfortable putting up your home as collateral for your loan. For instance, if you default on your credit card debt, Visa is not going to foreclose on your home. If you default on a home equity loan, however, you can lose your house through foreclosure.
Unsecured personal loans
If the thought of putting your home or other property as collateral does not work for you, you can try to obtain an unsecured personal loan. Unsecured loans have a higher interest rate and are often harder to obtain if your credit is poor.
There are three basic places you can look for unsecured personal loans:
- Banks and credit unions.
- Marketplace lending platforms.
- Nonbank direct lenders.
Banks and credit unions
Banks and credit unions are a good place to start, especially if you have an established relationship with them. Your local bank or credit union might consider offering you a debt consolidation loan along with credit counseling services to help you get out and stay out of debt.
If you can find a family member or friend with excellent credit who will agree to co-sign a loan with you, you might be able to get a more favorable interest rate. If you are fortunate enough to find someone who is willing and able to help you in this way, make sure you treat it like a business transaction. Remember that if you default on the loan, your co-signer will be legally responsible for repaying the full amount borrowed. The loan will also appear on both of your credit reports, so your payment behaviors will not only affect your credit but theirs as well.
Marketplace lending platforms
Marketplace lending platforms, which are sometimes called peer to peer (P2P) lenders, may be another option. Typically, marketplace lenders want to see a credit score of over 640, but they may consider a lesser credit score if you can explain your current financial situation to their satisfaction. For instance, if your credit scores have dropped recently because of unexpected financial hardship like the loss of a job, you may be able to persuade a P2P lender of your creditworthiness, as long as you’ve found another job and you are working to rebuild your credit.
Balance transfer credit cards
Getting approved for a balance transfer credit card with bad credit is not an easy feat. To acquire a 0% introductory rate balance transfer card usually requires having a good to excellent credit score. However, it is sometimes possible to find a card that will work for you even when you have poor or fair credit.
What about credit cards for people with bad credit?
If you are thinking about obtaining a new credit card to consolidate existing credit card debt, there are some important factors to consider. First, you may not be able to get a new credit card at all if your credit scores are too low.
Second, if you can obtain a new credit card, the interest rate on the new card may not be helpful in actually getting rid of your credit card debt. In many instances, you may find that simply paying more on your existing credit cards every month will work just as well or better than getting a new card.
Third, balance transfers are not free, as some might assume. Typically, there is a flat fee of 2% to 5% of the transferred amount, which will be added to your existing balance. These factors make obtaining a credit card for debt consolidation problematic for people with poor credit.
In case you do decide to go with this option, our low score credit card guide outlines all the options.
What are debt management plans?
Another option for debt consolidation is a debt management plan. Debt management plans are programs in which you agree to make a set monthly payment to a credit counseling company. The company then forwards these funds to your creditors until your unsecured debts are paid in full. A debt management plan offers credit counseling and education to help you identify your credit issues and avoid them in the future.
The credit counseling agency may negotiate with your creditors to see if interest rates can be lowered, but the agency does not negotiate to lower the principal balance that you owe. You will still pay 100% of what you owe over the course of 3 to 5 years.
It is important to note that a debt management plan may not always work to your advantage. Read the terms of the debt management plan carefully before agreeing to enroll in such a plan.
Why can debt settlement be a better choice than debt consolidation for people with bad credit?
Debt settlement is a drastic debt relief method you should not take lightly. However, there are circumstances when debt settlement is a better choice than debt consolidation if you have bad credit. Why? It is practically impossible to get an unsecured debt consolidation loan with bad credit. If you do qualify, the rates are probably prohibitively high. Debt settlement companies negotiate with your creditors to reduce the total principal amount of debt that you owe. This can really hurt your credit score. However, this may not be such a serious blow if your credit is already bad.
For instance, if you owe 5 creditors a sum of $10,000 in total, a debt settlement company will negotiate with each of your creditors to reduce the amount you owe each one. Your debt settlement company may be able to get your creditors to agree to reduce your total debt by as much as 30% to 50%. In this example, you could save $5,000 to $3,000 on your debt.
Debt settlement can have a negative effect on your credit score. But if you already have bad credit, you may find that the advantage of getting out of debt more quickly and paying a lesser amount than what you currently owe outweighs the negative effects on your credit score.
Secured debt consolidation loans vs. debt settlement
Secured debt consolidation loans, such as home equity lines of credit and cash-out mortgage refinances are different. If you have equity on your home, vehicle, or another valuable asset, you may qualify for a debt consolidation loan at reasonable rates. The downside is you may be switching unsecured debt into secured debt. In other words, you could lose the home or car that secures the loan if you don’t make payments on the loan.
When should you consider debt settlement?
Debt settlement should be considered as a viable option when you are unable to pay the full amount of the debt you currently owe. To preserve your credit rating, you will want to consider all your other options, including debt consolidation, before choosing debt settlement.
The largest drawback of debt settlement is its negative effect on your credit score. However, for those with poor credit, debt settlement may be the best solution because it enables you to get out of debt more quickly. Once completely out of debt, you can take steps to repair your credit and ultimately lessen the impact of debt settlement on your score. To explore your debt settlement options more fully, get a free debt settlement consultation.
The bottom line on debt consolidation options for people with bad credit
As with all financial decisions, it is important to examine all your options carefully before making a choice. Having bad credit really limits your options unless you have a valuable asset to place as collateral. However, there are still paths available, regardless of your credit. If you want to do something to handle your debt, do not procrastinate.
Find out what rates you qualify for with a debt consolidation loan by filling this short form. It won’t hurt your credit it will only take a few minutes. Then request a free consultation with a debt settlement company and see what they have to say. By this stage, your best course of action will be much clearer.