If you’re looking to save money on your existing debt by considering a debt consolidation loan, there are a few things to keep in mind. I had a friend approach me once, asking whether she should refinance or try debt consolidation in order to “package” her loans better. Sure, a single loan to replace all your loans at a lower rate is a great thing, but there are a few things to watch out for:
Debt Consolidation Tips
1. Determine if debt consolidation is worth it. Deciding to consolidate your debt into one cheaper loan (or loans) usually comes at a cost. Maybe you’ll have to pay for the privilege of getting the new loan, or it could be simply the time and effort of making it all work. It gets even more expensive if you opt to hire someone to help you out with this.
2. Stay disciplined and committed. When people choose to get a new loan to pay off old ones, it’s pretty much a matter of “fighting fire with fire”. But the risk here is that once you rework your debt set up with such a loan, you may become tempted to pile on additional debt because the lower payments could make you feel complacent. Don’t take things for granted just because you’re paying less towards your debt!
3. Maintain good credit. One of the biggest ironies in personal finance is that those who have the greatest need to take out loans are usually those who have the worst credit. Unfortunately, people with bad credit are the ones stuck with the highest fees and most expensive debt around. So to qualify for loans with the best terms, take care of your credit and use debt responsibly.
4. Be careful about collateralized or secured loans. You can consolidate your debt by using your home equity, but I wouldn’t do it. In some cases, it may be the “best deal around”, but understand the risks here: if you take out a HELOC to do a debt consolidation, just make sure you stay current with your payments or you could be risking your home. A twist to this idea is to borrow from your retirement account. This could be a cheap option to get cash, but if you don’t pay back your debt when it is due, you’ll face penalties.
That said, here are a few sources for potentially cheaper loans that can help you lighten your debt load if you do decide to consolidate your debt.
Best Debt Consolidation Loans For Those With Good Credit
These are my two preferred ways to consolidate debt using cheaper loans:
1. Check out lending networks.
If you’re what’s called a “prime borrower”, you’ll probably be able to take out a loan from your bank pretty easily. But you can actually go cheaper here, given your good credit. I’m surprised that not more people are familiar with a social lending network like Lending Club. They are around specifically to help people with good credit get personal loans at a lower rate than they’d get from traditional lenders. Lending Club is a peer to peer lending network that has the following benefits:
- You can borrow up to $25,000 through Lending Club.
- You are charged fixed interest rates (as opposed to some credit cards that have variable rates).
- You pay fixed monthly payments.
- Loans have a term of 3 years, which you pay through installments.
- Personal loan interest rates are typically lower than at credit cards or banks because the “middleman” is taken out.
- You can pay off debts in full without penalties (within 3 years or earlier).
- Your privacy is ensured.
To qualify as a borrower, you should have a FICO score of at least 660 and a debt to income ratio (minus your mortgage) that’s below 25%. Also, people who reside in certain states won’t be eligible to participate in this network. However, the company is working to have this service accessible on a national level.
2. Consider balance transfer credit cards.
Shop for low interest rate credit cards if you know that you’ll be keeping a balance. Also, if you’ve got decent credit but have high interest credit card debt, you may be able to lower your card payments by considering the possibility of moving your balance over to balance transfer cards, but only if they turn out cheaper for you in the long run. If you’ll be able to pay down your debt during the intro period, then these 0% APR credit cards can be a great choice. Watch out for balance transfer fees though, as you’ll need to factor these in when you determine whether it’s worth doing the transfer.
But What If You Have Bad Credit?
Now if you’ve got bad credit, you may be out of luck here. But let’s take stock of what you can do. Here’s what I’d do:
1. Work on cleaning up your credit. If you improve your credit score, you can eventually qualify for better terms on your loans and may be able to gain leverage with lenders. You’ll have a better chance at negotiating with financial companies if you’ve got good credit and are a good customer. Here’s more on how to repair bad credit.
2. Seek government assistance. Look into government programs that can help you get back on your feet as you resolve your debt issues. Debt and credit counseling may be available for free through local government or social agencies.
3. Be careful about hiring professionals. You can also hire for-profit specialists in the debt consolidation field. However, debt consolidation outfits, loan modification companies and debt settlement companies operate in murky territory so you’ll need to keep your eyes peeled for unscrupulous agents in these areas. Not to say that there aren’t any helpful service providers around, but note that these providers charge fees for work you can do yourself. And the truth is, you can’t trust anyone with your finances more than you can trust your own self.
Copyright © 2009 The Digerati Life. All Rights Reserved.
{ 19 comments… read them below or add one }
And don’t fall into the trap of borrowing “extra spending money” at the time of the loan!
You can also look for assistance in repairing your credit but as it is mentioned above, you should be VERY careful when hiring a company. Most companies in this industry are not on the up-and-up. Trust me, I have a little knowledge on the subject. Just be sure to do your research and ask as many questions as possible. If the story you get from a credit repair company sounds too good to be true, it probably is.
@John,
Very good point — a lot of people feel that since they’re getting a “new loan” anyway, that perhaps padding it just a little bit more may be a good idea; you know, since they’re going through the effort of obtaining a loan anyway. Never forget that borrowing money has a cost, and in most cases, it’s hefty.
@Lawrence,
For-profit debt management specialists/agents aren’t magicians. Whatever they can do, you can do yourself. People go to them for help because they’re usually at the end of their rope or just want to offload the “stress” of dealing with their debt/bad credit. In some cases, they may be able to help — I knew a couple who turned to a financial adviser and debt counselor to help them clear their credit card debts, and it worked.
But in other cases, this may indicate that the one seeking financial help is wanting to shirk responsibility — if one’s attitude is to “have someone else take care of the problem”, then it could make you an easier mark for scam artists or could make you a target to be taken advantage of. Take control of your finances, even as you ask for help!
Thank goodness I am practically debt-free, and learned most of these lessons years ago. Far too many people are just living way above their means, on dodgy credit, and I reallt feel for them. Thank goodness there is information like this available on the internet to help people make educated decisions as how to address their debt issues.
awesome article.
I never really saw getting into more debt as a good way of getting out of debt.
@WPB
The idea is to actually try to “move your debt around” so that you get lower rates, not necessarily to “get into more debt”. If you do this right, it could be cheaper for you in the long run and could get you out of debt faster. If you do this wrong, well… you can get screwed. Up to you to make this work.
Don’t be afraid to settle your debt yourself. It’s generally better than hiring a debt settlement company to negotiate your debts. There are a lot of phony debt settlement companies out there these days.
I settled my debt successfully myself with the assistance of a debt settlement coach. Do it yourself does not have to mean by yourself.
Make sure that you check all debt consolidation companies you’re thinking of doing business with, against the Better Business Bureau!
Many customers ask me about debt consolidations. My first response is always to ask whether they can borrow from a friend or relative and repay at a reasonable rate. The problem is that most people do not have anyone with spare cash to lend.
So, the best method is to refinance or tap into your home equity with a HELOC. Not only will your total monthly debt payments be lower, but if you WERE able to afford those higher payments, you can still make the higher payments against your new low monthly REQUIRED payment. The net result is not only will you pay less in interest but the balance will be repaid much faster. The final bonus is the interest on your primary residence can be deducted on your tax returns.
One thing to remember is that most social lenders require a minimum credit score (generally between 540 and 650) before you will be considered for a loan. Just thought I’d throw that out there in case someone with bad credit thinks they can just get a loan through one of these avenues.
Thanks CCCG — I have listed in my article above that social lenders REQUIRE a good credit score, hence I emphasize financing options for those with GOOD credit. Social lenders emphasize that they aren’t loan companies but lending networks that match up lenders/investors and borrowers. I believe that a lending network may find the most success when they stick to prime borrowers and screen for those with the best credit. These days, investors are wary of taking that extra risk for the extra reward. In my particular case, I am an investor and I wouldn’t mind receiving a lower reward if it meant that my risks were well managed. I think that a lot of personal lenders may prefer to lend money to those whom they knew would pay them back on a consistent basis.
This is a well written and balanced article. I have negotiated my own debt successfully and from my experience I fully agree that hiring a debt settlement company is a bad idea and that you are better off settling your debt yourself.
This article is also right on the mark regarding debt consolidation. 75% of people who enter debt consolidation programs still end up in bankruptcy, and it also negatively affects your credit on top of it.
Settle your own debts just like I did and you’ll be way ahead of the game.
Debt consolidation can simply be from a number of unsecured loans into another unsecured loan, but more often it involves a secured loan against an asset that serves as collateral, most commonly a house. In this case, a mortgage is secured against the house. The collateralization of the loan allows a lower interest rate than without it, because by collateralizing, the asset owner agrees to allow the forced sale of the asset to pay back the loan. The risk to the lender is reduced so the interest rate offered is lower.
The most common type of bad credit debt consolidation loan that people get is secured home equity loans. These loans are popular because they offer low interest rates to borrowers with poor credit. This is important because traditionally poor credit borrowers usually have to pay higher interest rates for their loans. Getting a home equity loan can give you the best rate available for your loan. The only downside of this loan is that you will lose your home if you do default, so be careful before taking an equity loan out.
Even when people consolidate their debts into a new loan, they need to be disciplined enough to not enter into new debt.
I think this option may work for some but for many it can spell disaster for many. These companies that are private companies promote themselves as debt relief organizations use marketing ploys to persuade people to turn to them but do not offer the best personalized solutions to reducing debt.
The first thing to do is call your creditors and explain your predicament to them. Most companies are very reasonable and will allow you to make smaller payments until your situation improves.
I need to pay my debts via consolidation!