Debt Consolidation

If you’re trying to manage bills that are piling up, you may have come across the idea of consolidating them. Consolidating your debts can be convenient, allowing you to make one monthly payment. It can also allow you to swap high-interest debt for low-interest debt. However, it has drawbacks and is not right for everyone. Here are some debt consolidation strategies to keep in mind as you plan for paying off your debt:

Balance Transfer
A balance transfer involves opening a new credit card with a low interest rate (for a promotional period). You then move your previous debt(s) to this new credit card. In effect, you will have reduced your interest rate from a high rate on the old debt to a lower rate on the new card.

You will typically pay a fee for the amount you transfer (although some cards waive the fee for applicants with excellent credit), and there will be a limit to how much you can transfer (meaning you may not be able to transfer all of your existing debt).

This is a smart strategy IF:

• You have good enough credit to receive a low percent promotional rate. Note: it is an even better strategy if you have excellent credit and can avoid a transfer fee.
• You will pay off all the debt transferred before the promotional interest rate expires.

A Debt Consolidation Loan
A consolidation loan works much like a balance transfer, but you would be receiving a loan rather than a line of credit. The process would involve opening the loan, using funds from the loan to pay off the previous debt(s), and then repaying the loan. Like with balance transfers, better terms will be reserved for borrowers with good to excellent credit.

To make this strategy worth it, a borrower should only accept a loan with an interest rate significantly lower than the rate on the existing debt(s). Some lenders may charge origination fees, but borrowers should shop around and try to avoid such fees.

This is a smart strategy IF:

• The loan provides better terms than any balance transfer available to the applicant OR the applicant is concerned about being able to pay a balance transfer debt during the promotional interest period.
• The interest rate on the loan is significantly lower than on the previous debt(s), meaning the borrower has good to excellent credit.
• The borrower can avoid origination fees.

Debt Management Program
The two strategies discussed so far are primarily reserved for people with good to excellent credit. But what about if you have high interest debt and a credit score that is not good or excellent? In that case, there are some options. A few involve significant risks, and we do not generally recommend them (things like HELOCs. However, a debt management plan may be a good fit.

In a debt management plan, you work with a credit counseling to pay off your debts. The counselors have relationships with creditors, and in many cases your creditors will reduce interest rates and waive fees while you are on the plan. The plan is structured so that the payments are manageable, and the plan continues until you pay your debts is full.

You make one monthly payment under the plan, and the counselors distribute that payment to your creditors. So technically, a debt management plan is not a form of consolidation. That is because under the plan your accounts remain separate and are not consolidated into a new financial commitment. However, it provides the benefits of consolidation, because you only must make one monthly payment and you often receive reduced interest rates.

Additionally, the counselors provide financial education and are there as a resource for you throughout your repayment process.

This is a smart strategy IF:

• Your credit does not qualify you for good rates on a balance transfer or consolidation loan; AND/OR you would like to have a counselor resource and financial education during your repayment; AND/OR you have experienced a financial setback such that even if you received good terms on a consolidation product, it would be difficult to make payments.
• You have primarily high-interest unsecured credit card debt.