If you’re overwhelmed by debt and are desperately seeking relief, debt consolidation may be a viable option. But how exactly does it work, and how do you go about finding a loan that best suits your needs? Read on to learn the answer to these questions and much more.
How Debt Consolidation Works
In a nutshell, debt consolidation refers to the practice of rolling small debts into a single debt product. By doing so, you’ll streamline the repayment process since all the other creditors will be paid in full by the loan process. It’s also designed to save you money if you’re able to secure a loan interest rate.
You can consolidate your debts by taking out a personal or home equity loan, opening a balance transfer credit card, or borrowing from your 401(k).
Benefits of Debt Consolidation
Scores of consumers who are drowning in debt turn to debt consolidation for the benefits they can derive from it, including:
- Lower interest rates; perhaps the most attractive part about debt consolidation is the ability to pay a ton less in interest than what you were paying before, which could be hundreds if not thousands over the life of the loan (assuming you qualify for a debt product with a lower rate or secure a balance transfer credit card). If money was tight but you were keeping up with the monthly payments, a lower interest rate will not only give you a lower combined monthly payment, but free up funds that can be used to get the total amount owed down even faster. But if you were struggling to make timely payments, a lower interest rate could mean you’re now able to silence the collection calls by paying those balances and full using loan proceeds and taking care of the loan balance that remains without feeling overextended each month.
- Peace of mind: instead of spending hours each month mulling over your debts figuring out if a creditor has been paid and how to knock down the outstanding balances faster, you can rest assured that a loan payment has you covered. This is also a major bonus if you’re tired of dealing with fees from late payments or creditors breathing down your neck.
- Potential credit boost: if you’re consolidating credit card debt, paying off the balances will automatically decrease your credit utilization ratio, which accounts for 30 percent of your FICO score and is comprised of revolving credit. This is a win-win for your wallet and your credit score.
Drawbacks of Debt Consolidation
While there are several benefits to consolidating your debt, there are also a few drawbacks to keep in mind.
For starters, debt consolidation is not without risk and could set you back even further financially if not executed properly. To illustrate,
You should also consider the fees associated with debt consolidation. Personal and home equity loans are usually accompanied by origination fees, which account for one to three percent of the total loan amount. Furthermore, you could incur a prepayment penalty should you decide to pay the loan off early.
With regards to balance transfer credit cards, your efforts could backfire if you’re unable to pay the amount owed in full prior to the promotion’s expiration date. Why so? The creditor will retroactively apply interest to the debt that remains.
Another important consideration is in regards to home equity loans. If you default on the payment, you could put your home at risk since it’s a secured loan product backed by your home (which is used as collateral).
Furthermore, balance transfer credit cards that aren’t managed properly could result in even more than you have beforehand. How so? Well, if you decide to use the other cards that have already been wiped clean, you’ll end up right back in the same spot that you were before with double the debt.
How to Evaluate Debt Consolidation Lenders
Ready to move forward with consolidating your debts? If you do a quick search for debt consolidation lenders, chances are you’ll quickly become overwhelmed as there are so many options out there.
But you can narrow down your list by only analyzing lenders that offer products that you need and keeping the following in mind:
- Qualification criteria: is there a minimum credit score or monthly income that applicants must have to be considered for a loan? Also, does the lender require you to be employed for a set period of time in order to consider your loan application?
- Loan terms: is the interest rate lower than what you were paying before? And is the loan term much lengthier or shorter? Higher interest rates defeat the purpose of consolidating your debt and significantly longer loan repayment periods could mean you’ll pay a lot more in interest over the life of the loan than you would have if you had not consolidated the debt.
- Key benefits: does the lender offer any particular perks that make them stand out from the others? For example, some lenders offer pre-qualification screening tools to help you assess if their products are a good fit without dinging your credit score. You may also be able to customize your loan to best suit your needs.
Best Debt Consolidation Loan Companies
| Lender | Loan Amounts | Loan Terms | Key Benefits |
| Avant: online direct lender that’s helped over 600,000 secure the funds they need | $2,000 to $35,000 | APR: 9.95% to 35.99% Repayment Period: 24 to 60 months Administration Fee: Up to 4.75 percent | -loan prequalification tool that does not impact your credit score -next business day funding options available -no prepayment penalties |
| Earnest: online direct lender that puts technology at the forefront to offer borrowers more competitive interest rates | Up to $75,000 | APR: starts at 6.99% Repayment Period: Varies by lender Origination Fee: 1% to 6% | -savings patterns, asset portfolio, and work history considered by the lender during the loan application review process -customizable repayment plans |
| Lending Club: peer to peer lending network that’s served over 2.5 million customers | Up to $40,000 | APR: 6.95% to 35.89% Repayment Period: | -prequalification tools that allows you to check your rate with no impact to your credit score -funding in as little as seven business days -no prepayment penalties |
| Lightstream: a direct lender that’s a division of SunTrust Bank | $5,000 to $100,000 | APR: 6.14% (with AutoPay) Repayment Period: 24 to 84 months | -competitive interest rates for well-qualified borrowers -same business day funding options available -no prepayment penalties |
| OneMain Financial: a direct lender with over 100 years experience | $1,500 to $30,000 | APR: varies by loan product Repayment Period: varies by loan product | -check your offers without impacting your credit score -over 1,600 brick and mortar locations available -no prepayment penalties |
| Payoff: a direct lender that offers loan products designed to help you eliminate credit card debt faster | $5,000 to $35,000 | APR: 5.99% to 24.99% Repayment Period: 2 to 5 years Origination Fee: 0% to 5% | -view rates without hurting your credit score -no late or returned check fees |
| Prosper: a direct lender that has loaned over $13 billion to consumers | $2,000 to $40,000 | APR: varies by loan product Repayment Period: 3 or 5 years Origination Fee: 2.4% to 5% | -no penalty to your credit score to check your rate -no prepayment penalties |
| SoFi: | Up to $100,000 | APR: 6.99% to 15.49% (with AutoPay) Repayment Period: | -no impact on your credit score to check your rate -no origination, late, or prepayment penalties |
| UpStart: peer to peer lending network that connects borrowers with lenders | $1,000 to $50,000 | APR: 8.89% to 35.99% Repayment Period: 36 months (on average) | -check your rate with no impact to your credit score -lenders consider your educational background and work experience when evaluating your loan application -next business day funding options available -less than perfect credit OK -no prepayment penalties |
Debt Consolidation vs Debt Settlement
Maybe you’ve done some legwork and determined that debt settlement isn’t for you. The good news is all hope is not lost as debt settlement could still offer you the relief you’re seeking.
But how does it differ from debt consolidation? In a nutshell, you will settle your outstanding balances for a fraction of what you owe in lieu of paying them in full through debt consolidation.
While doing so could adversely your credit rating when the creditor when the creditor settles the accounts in their books, it also means the hounding debt collection calls and letters will stop. Furthermore, the creditor cannot come back at a later date to sue you in the court of law for the remaining portion that you owe.
You should also only consider using debt settlement as a last resort before filing for bankruptcy because it’s really only effective once you’ve missed a slew of payments and the creditor believes there’s a high possibility they won’t recoup the funds they’re owed. Unfortunately, this means you’ll have to stop making payments altogether for the debt settlement company to plead your case and have the greatest chance of success. But keep in mind that there are no guarantees that creditors will accept the offers presented to them, so there’s always the risk of failure.
If you believe debt settlement may be a good fit, be sure to only do business with a reputable company as there are tons of scam artists out there. A few options include Accredited Debt Relief, Freedom Debt Relief, National Debt Relief, and New Era Debt Solutions.
The Bottom Line
Debt consolidation may be worth a shot if you earn a consistent income each month and can comfortably afford to make payments each month on your debts. But if you’re completely overwhelmed and can’t seem to see the light at the end of the tunnel, debt settlement may be a more viable option.
Either way, by exploring these reputable companies and what they have to offer, there’s a high possibility you’ll be on the way to breaking the chains of debt in record time.