How to Consolidate Debt

Guide Note If you feel buried in all the bills you receive each month, it might be time to consolidate debt into one or two easy payments you'll be sure to make, thus avoiding late fees and interest rate hikes. With a little research, you'll be well on your way to consolidating debt on your own or with help from a debt professional.

Table of Contents

Debt Consolidation Tips

  1. Consider negotiating with lenders for lower rates before consolidating.
  2. Make sure that if you borrow against your home or car that you'll be able to make payments.
  3. Find a low introductory rate on a new credit card and transfer high balances to that card.
  4. Think creatively about how to consolidate debt: borrow from a life insurance policy, retirement, or even a relative.
  5. Make sure the debt counselor or consolidator you choose is accredited and that you trust him or her before moving forward.

Disclaimer The content in this page is not a substitute for professional financial advice.

Introduction

(Creative Commons photo by Mike)
(Creative Commons photo by Mike)
  • Debt consolidation has become an increasingly popular way to manage debt, potentially lower interest rates, and reduce the number of creditors to whom you are beholden. While some debt consolidation agencies have earned bad reputations for charging exorbitant fees that trump the savings you may experience by consolidating, others will provide genuine help (albeit for a fee) in getting the deeply in debt the help they need.
  • If you have the discipline and organization skills—and don't forget punctuality—it's entirely possible to be your own debt consolidator. Between transferring credit card balances, consolidating student loans, and refinancing your home or car, there are many steps you can take to lower monthly payments and eradicate extra bills.
  • Whichever path you choose, it's crucial to evaluate not only the debt you're in but how you got there. Your spending habits likely had the biggest influence on your debtload, so as you research carefully the consolidation options out there, be sure as well to put a microscope on your budget, because part of consolidating your debt involves finding the money to pay it off, one debt at a time.

Step 1: Is Debt Consolidation Right for You?

(Creative Commons photo by Eliazar Parra Cardenas)
(Creative Commons photo by Eliazar Parra Cardenas)
  • The prospect of paying off certain debts or simply reducing the number of bills you pay each month is indeed tempting, and often it is the right move financially. Depending on your particular situation, however, consolidation is something to consider very carefully.

Questions to Ask Yourself

  1. Consider your credit score before you try to consolidate your debt. If you have significant debt that's gotten you into trouble in the past, you may not even qualify for interest rates that will truly help ease you out of debt.
  2. Is it possible to do some renegotiating before launching into an elaborate consolidation plan? If you lowered your interest rates, would that make the difference? Your mortgage lender may lower your rates in order to avoid your defaulting on the loan. The same is true for your student loan administrators and even your credit cards.
  3. See Mahalo's page on How to Lower Your Credit Card Rates to learn how to get your credit card companies to start charging you less interest every month.
  4. Most important, you'll need to be honest with yourself about how realistic it will be to pay back the additional debt you're taking on. And the statistics are rather grim:
      • "70% of Americans who take out a home equity loan or other type of loan to pay off credit cards end up with the same (if not higher) debt load within two years." [1]

Step 2: Consolidating on Your Own

  • If you want to attempt to consolidate some of your debt yourself, that is certainly doable. Just remember to stay organized, and make payments on-time, or you could lose that low interest rate you worked so hard to find.
  • The type of debt you are carrying and whether you own a home, are eligible for lower rate credit cards, or have a relative willing to offer you a loan will all help you determine how to approach your consolidation efforts. You might choose to use one or more of the following sections depending on your particular situation.

If You Are a Home Owner

(Creative Commons photo by James Thompson)
(Creative Commons photo by James Thompson)
  • Homeowners have the most flexibility to consolidate other types of debt because they have a major asset to borrow against and the interest you pay on a home equity loan is most often tax deductible. But consider a home equity loan carefully before applying for one.
  1. If you own your own home, you may be able to apply for a home equity loan to pay off debts.
  2. You might be able to enjoy a tax deduction for the interest on this type of loan, as well.
  3. It is only wise to take out a home equity loan if you know what you are getting into, since your collateral in this case is the home you live in—not something you'll readily give up if you can't make payments.
  4. Though the bank may approve you for a higher loan, be sure to borrow only what you need against your home so that your payments are manageable.
  5. Beware some of the horror stories that are out there. If you can't pay off the loans you take out against your home, you may find yourself free of credit card debt or car payments, but one day, you'll also be out of a home.
  6. Because home equity loans tend to stretch out payments over a longer period than other loans, try to pay extra each month, at least as much as you were paying so that you remain on track in terms of your debt consolidation (and elimination!).
  7. Compare current loan rates at Bankrate's Home Equity Loan comparison tool.
  8. You may want to seek the advice of a financial professional who can assess your home's value and your current financial situation before advising you to take out a loan against your home.

Consolidating Credit Card Debt

(Creative Commons photo by Cheon Fong Liew)
(Creative Commons photo by Cheon Fong Liew)
  • If you don't own a home and have debt across multiple credit cards, or even just a couple of relatively high interest rate card, you may want to consolidate to a lower interest rate card.
  1. It can make sense to consolidate credit card debt if you are able to secure a lower interest rate card than what you are currently carrying.
  2. If you plan to apply for a new credit card to which you will transfer balances to consolidate debt, see Mahalo's page on How to Get a Low Interest Rate Credit Card so you can find the card that will offer you the lowest interest rate or best balance transfer offer.
  3. Use Bankrate's card search tool to compare offers, too.
  4. Only sign up for an introductory offer (usually a low rate, even 0% if you're lucky, for a specified period of time) if you know you'll be able to pay off the balance before the rate jumps. Example: If you're currently paying 12% interest and you switch balances to a 0% rate but after three months it skyrockets to 18%, you won't have gotten yourself anywhere unless you've paid the balance off.
  5. You should also do careful research on any associated fees or charges to make sure you're really saving. And pay on time—introductory low rates often jump after just one missed payment.
  6. If you consolidate your credit card debt onto one card, ideally with the lowest interest rate you can get, continue to keep your old accounts open. You'll build credit history this way, and creditors will see that you have "open" credit available to you.
  7. But if you think you might start racking up more debt on those cards, it's better to close the accounts and wait for your credit score to improve. It will plummet later if you can't make the payments on your loans, anyway.
  8. Remember that consolidating credit card debt may lower your credit score, at least temporarily, because you'll be carrying all your debt on just one card (i.e., likely getting close to, or maxing out, your credit limit—the higher the percentage of used credit, the more of a risk you seem to creditors).
  9. You may wish to request a free credit report before consolidating credit cards to determine if you can afford to lose a few points on your credit score. And, if you aren't planning on making any major purchases very soon, you'll have time to build up your credit score again.

Alternative Options

(Creative Commons photo by Peter Dutton)
(Creative Commons photo by Peter Dutton)
  • If your debt has truly gotten the better of you, it might be time to think about additional creative solutions, like borrowing against retirement or even from a family member.
  1. If you have a retirement plan, like a 401(k) plan, for example, you may be able to withdraw funds to pay off debt, but you should only use this money as a last resort or if you are truly over your head in debt.
  2. Remember that when making withdrawals from retirement funds, may pay a fee or taxes on the amount you take out.
  3. If you have student loans, you may be able to pay less in interest by consolidating, freeing up additional cash to pay down other debt. See Mahalo's page on How to Consolidate Student Loans to learn the finer points of combining your student debt into one or more payments to lower interest rates.
  4. Refinancing your car, like refinancing your house, is another way to free up extra money to pay down debt. Just remember that like with your house, your collateral in this case is what you may need to get to work every day, so only do this if you know you'll be able to make the payments.
  5. You may also be able to borrow against a life insurance policy to pay off existing debt.
  6. Your credit union may be another option that will offer you a lower rate on loans than what you are paying currently. You can therefore take out a loan with your credit union and transfer your existing loans to it, lowering payments and lowering interest paid over time.
  7. Finally, and almost all our sources discouraged this idea, but if you have a family member who is genuinely interested in helping you get out of debt, a personal loan might not be the worst thing to consider. Just be sure to draw up specific repayment terms or a contract and be sure you pay Aunt Sally back!

Step 3: Contacting a Debt Consolidator

(Creative Commons photo by John Pearson)
(Creative Commons photo by John Pearson)
  • A professional who can guide you through the consolidation process, helping you to lower monthly payments and reduce overall interest paid over time can be a lifesaver. Some experts say that you should start with a non-profit consumer credit counseling agency before attempting to consolidate debt on your own.
  • A consumer credit counseler will not be judgmental about your debt. As one expert put it, they've "heard it all." You'll want to be careful whom you choose to consult, however, as there are some disreputable agencies out there who will end up charging you more than you're already paying on your debt. Continue reading the following steps to find a credit counselor who will be right for you.

Research a Credit Counselor and/or Debt Consolidation Loan Offers

  1. Organizations like the NFCC, the National Foundation for Credit Counseling, come highly recommended from financial experts.
  2. Because the NFCC's fees are paid by creditors, not consumers, they have a significant incentive to work out a repayment plan that you can afford and stick to.
  3. And a counselor, unlike a new loan, will help you face the debt you're in instead of pretending it doesn't exist, which is often the first crucial step to paying it off in earnest.
  4. Use the NFCC's Member Agency Locator to find an agency near you. Or, schedule a consultation over the phone by calling 1-800-388-2227.
  5. Be sure you don't sign up for the first consolidation loan you see. "Shop around," say the experts at Bankrate, just as you would for anything in a competitive marketplace to be sure you are getting the best deal.
  6. To avoid being taken advantage of by firms hoping to exploit those in debt, be sure to look up agencies in the Association of Independent Consumer Credit Counseling Agencies, or the NFCC, both of which will provide references on an agency you are considering.

Determine Fee Schedule Up Front

  • While finding a debt consolidator or taking out one lump debt consolidation loan to cover all your existing debts might seem much more organized and convenient, be sure you aren't paying a premium for the service.
  1. Calculate all fees beforehand so you can be sure that what you'll save in interest outweighs what you'll pay for the convenience of this kind of loan.
  2. It is a case of "buyer beware" when it comes to finding a debt consolidator, whether you're looking for a counselor or a new loan: if you feel uncomfortable or the agency is unable to explain its fee structure or how your loan will work, go find another agency.

Conclusion

  • Debt consolidation, much like debt itself, can be a daunting prospect and one that will require you to do your research carefully. With due diligence, however, there are multiple ways to reduce your debt load and eliminate extra payments each month, whether you choose to devise a system that works for you or you consult an expert to guide you through the process. Regardless of the path you take towards debt consolidation, being honest about your debt and your ability to pay back a new loan is crucial. Old habits die hard, but to eliminate debt from your life will mean more than consolidating a few credit cards, it will mean taking a hard look at your spending and genuinely trying to live within your means to stay out of debt. Stay focused and good luck!

Subscribe to Mahalo's Weekly How To Email Newsletter

  • Get our best How To tips and ideas in your inbox each week

Resources for How To Consolidate Debt




Didn't find what you were looking for?

Ask a question about How to Consolidate Debt


110 characters left.