The Guide to Debt Consolidation

couple debt consolidation

It’s easy to think of debt as a single thing. Like a lump sum of money you need to pay back rather than the collection of student loans, credit cards, car loans, mortgages, personal loans and even payday loans you’ve amassed – all with different payment dates, all with different payment amounts.

For most of us, our debt is a collection of messy numbers. You have bills due all month for different amounts and getting ahead of all of the payments can feel overwhelming. Debt consolidation is designed to make the process of managing and paying off your current debt easier.

What You Need To Know About Debt Consolidation

Imagine how much easier it would be if you only paid one bill for loans and credit card every month instead of six or seven. What your spending might look like if you weren’t constantly chasing overdue loan payments.

Debt consolidation is designed to do exactly that. It is a personal loan that combines some or all of your debt into a single loan so that you can make one payment every month rather than several. Additionally, a debt consolidation loan will often lower your overall debt payment and help you ultimately pay off your debt.

Debt consolidation is not a debt repayment plan. Debt management companies might offer to help you create a debt repayment plan that can negatively impact your credit by settling your debts if companies are willing.

Debt consolidation is a type of short term loan that you arrive that is large enough to pay off multiple smaller loans. You use the consolidation funds to pay off the smaller loans in full, and then make a single payment to the new consolidation loan instead of the smaller ones. You don’t wind up with bad credit by setting debts. In fact, paying off the multiple smaller loans or credit cards can actually boost your credit score.

Options for Debt Consolidation

Debt consolidation is a single, large loan that is deposited directly into your bank account so that you can pay off smaller debts in full. There are multiple options for lenders who offer personal loans for these purposes.

  • Traditional banks – Many traditional banks offer debt consolidation loans. These loans are often
    tied to stringent requirements for certain credit scores or income levels.
  • Credit unions – Much like banks, credit unions offer debt consolidation loans to existing customers. Some credit unions may have more flexible criteria for loans based on your banking and lending history with the institution.
  • Online lenders – There are many online lenders who are willing to offer personal loans and debt consolidation loans. Some online lenders follow the same criteria for approval as traditional banks, especially if they are affiliated with the bank, but others are willing to consider those with bad credit.
  • Retirement loans – If you have a substantial retirement account, you may have options to borrow against your own retirement for debt consolidation. You would essentially take a loan from your own retirement income through your 401k. You are borrowing your own money, which is nice, but this option has the downside of pulling funds from your saving plan which can impact your retirement income down the road.
  • Home equity loans – Much like borrowing against your retirement, you can borrow against the equity in your home for debt consolidation. If you have equity, you take out a loan with your home as collateral. Be aware that failure to repay a home equity loan can result in losing your home.
  • Friends and family – If you are comfortable asking family for a large loan (and they have the funds available to help) you may be able to avoid a bank altogether. Of course, borrowing from family can have significant impacts if you fail to repay the loan.

How to Fix your Debt Situation

When you are ready to get started consolidating your debt, applying for a loan is not actually the first step. Your first step is to consolidate your debt on paper first – not through a loan.

Step 1: Organize your debts.
Start the process of debt consolidation by writing down every single debt you have. In addition to listing the type of loan, list the specifics about the loan as well including the total you owe, the minimum payment and the interest rate you’re paying. Using a table, apps or software like Excel can help in this process.

Step 2: Compile the totals.
Once you have a list of debts, add up both the total amount you owe to all of your lenders and how much you are making in minimum payments to every card or loan. You would benefit from compiling subtotals as well. How much are you paying just for credit cards? How much for your home and vehicle?

Step 3: Decide what you want to consolidate
While it sounds great to consolidate everything into a single payment, it may not be very realistic. If you have a mortgage and an auto loan, for example, you may owe too much on those accounts to be able to cover them with a personal loan.

Use the subtotals you created to see where you are paying a lot at high interest rates. The higher the interest rate you’re paying, the less you’re actually affecting the balance of the loan with your payment every month. A car loan with a 3% interest rate isn’t making you pay much for borrowing the money. A credit card with a 22% interest rate is making you pay more for the interest than you ever did for the purchase.

Ultimately you want to consolidate as much as you can (or want) using a single loan with an interest rate lower than what you’d be paying on the original debt. Credit cards with a combined balance of $10,000 and interest rates between 19 and 26% might be consolidated using a debt consolidation loan, for example.

Combining multiple cards into a single loan for $10,000 at 12% would not only reduce the amount you’re spending every month on minimum payments, potentially by hundreds of dollars, but it would also help you clear the debt more quickly since debt consolidation loans have a set end time, unlike credit cards which will keep calculating interest.

Once you have decided on what you want to consolidate and you’ve determined how much you’ll need to actually cover the debt, it is time to start looking at financial options.

Step 4: Arrange a debt consolidation loan.
As discussed previously, you have several options for debt consolidation loans. You can ask to borrow money from a family member or take money out of a retirement account. Many individuals and families use personal loans as a way to pay off debt. These debt consolidation loans can be arranged through a traditional bank or credit union, but can also be arranged online.

If you are applying online for a personal loan, you will find a wide range of competing lenders with different requirements in terms of credit scores and income levels. There are several websites that aggregate lenders into a single portal. With these sites, you fill out a single application and then the website will send your application to the various lending institutions it has collected that are likely to consider lending you money.

After applying, the website may offer you multiple choices for loans from a variety of vendors. If you applied through a single vendor, such as an online bank, you might have several options for the type of personal loan to consider.

Once you have some options to consider, look again at your interest rates and subtotals from your own spreadsheet or list. A personal loan with an interest rate higher than you’re paying now isn’t going to help you pay down debt in a timely way.

Also check the minimum payment for the new loan options against your own budget. If you are able to make the payments on all of your debt now, a minimum payment that is roughly the same combined amount might help you pay down debt more quickly without affecting your budget. But if you are struggling to make minimum payments every month, look for a loan with lower payments, even if it means paying for an extra six or twelve months.

Step 5: Wait for funds
Once you’ve selected the loan that meets you specific needs, you may need to send additional documents like a paystub or tax return form. Submit those documents and address any additional requirements or concerns from the lender. Once you’ve done everything on your list, the loan will be
prepared by the lender.

Depending on the lender, the funds for the debt consolidation loan may arrive within a few days or more than a week. Once funds do arrive, they are typically deposited directly into your bank account so that you can use them immediately to begin paying off debts.

Step 6: Pay off the selected debts.
Earlier in this process you selected the debts you wanted to pay off using your newly gotten debt consolidation funds. Now that the funds have arrived, it’s time to put the money to work. Check the website or statement for every debt you earmarked to pay off. Find the payoff amount or balance on the loan.

Set up a series of payments to the various lenders that will pay off the accounts in full. If you did your math well, your debt consolidation loan should completely cover the full amounts of the selected debts.

Once you’ve set up payments or paid the items off through the respective websites, you will need to decide if you want to close the various credit cards and lines of credit affected. Closing a credit card after it is paid off will prevent you from ever being tempted to use it to buy something in the future. It might also save you from being charged a monthly or annual fee.

On the downside, you may be losing positive points on your credit score by closing out multiple cards. Depending on how you’ve set up your payments, it may be a few hours or a few weeks to have all of the debts completely paid off.

Step 7: Manage the debt consolidation loan.
Don’t forget that a debt consolidation loan is still a loan. It will need to be repaid in a timely manner to avoid causing you new debt problems in the future. Be sure to track the payment dates on your loan so that you can make timely payments. A major advantage of a debt consolidation loan is that you will only need to make a certain number of payments before the loan is completely paid off.

How to Manage your Debt Moving Forward

A debt consolidation loan can help you clean up your finances and move forward without the weight of debt crushing your budget and your spirit. There are many things to celebrate once you’ve finally cleared out troublesome debts and you’re on your way to financial freedom using your consolidation loan.

You might have more money every month to cover other costs or saving goals. You have a specific date when you’ll be debt free. Your budget is simplified by the single payment instead of several. But there are a few things you need to be mindful of as you move forward with your debt consolidation loan. You have just paid off numerous debts and loans using a new loan. While you may have a bit of extra room in your budget, you still have a large payment to handle on a regular basis if you want to stay
on top of the loan.

  • Avoid new spending that will create new debts or burdens you will need to shoulder in addition to your new loan payment.
  • Don’t use the credit cards you’ve recently paid off with your consolidation loan. You will wind up owing even more money than you did before.
  • Look for other ways to shave costs or cut spending to make the new loan payment even easier to pay. This is especially true if you borrowed against your retirement or your home.
  • Work hard to manage your bills and finances in a new way to avoid the need for future debt
    consolidation. Remember that spending habits can be hard to break just like any other habit.