Debt consolidation is an incredibly useful tool, right up to the point where you make the wrong choice. Like so many of our financial decisions, good intentions don’t always lead to good outcomes, so you need to know how and why you’re consolidating debt - and which debts are worth consolidating - before you make any moves.
In this post, I’m going to start with the basics, from the definition of consolidation, and then covering some of the greyer areas that have people struggling with debt management. By the end, you should have a clear idea of how to handle those outstanding balances, if they indeed need to be handled.
If you’re fresh out of school and about to start making your first loan payments, consolidation might sound completely foreign to you. Some companies present it as a way to get rid of debt, which can lead to great disappointment when you find out that none of the money you owe will magically be wiped off your record.
Consolidating debt just means lumping all the balances you have together, making one large loan with one large monthly payment. One large sum of debt might sound scarier than several smaller amounts, but if the interest rates get lowered when combined, you end up doing yourself a big financial favor.
Every so often, consolidation and management get confused, and while you can make consolidating part of your management plan, the two don’t mean the same thing. Managing debt is more about planning, looking at which balances need to go first and how much you can put toward everything in any given month. Some people bring in a third party for the management leg of the journey toward financial freedom, which isn’t a bad idea if you can afford the help.
There’s a third term I’ll mostly avoid, but it’s still worth mentioning, and that’s debt settlement. It sounds great and can be incredibly helpful for certain people, as the lender accepts a lower amount than what you owe as a means of getting something instead of nothing. However, if you can get the financier to settle, you’re still likely to take a big hit on your credit score and spend a long time recovering from that, perhaps even longer than you would have spent paying down the full amount of debt.
Consolidation is great, management is important, and settlements should not be viewed as a viable option. If you get to the point of settling, you’re in pretty deep.
If you have credit cards, student loans, and any additional balances dragging you down, consolidating can make an immediate difference for your situation. The question then becomes how and where to consolidate. There are plenty of options, perhaps too many, and the right choice will depend on the debts you have and the rate you need to make consolidating worthwhile.
The type of debt on your balance sheet will often determine which lender you should use. The best example of this is going with a student loan refinancing company, such as Splash Financial. Many of us leave school with numerous student loans that have varying interest rates. You might not even know that your debt consists of 11 different balances, but that’s part of the game lenders play to keep you overpaying.
Should you have lots of student loans that might be more easily handled if they were in one tidy package, a refinance company is likely the best option. While you’re still getting a standard loan to cover all your other balances, you’ll always be better served by a lender that understands your situation.
This is part of the reason I recommend Splash over other companies for recent graduates. The team there has a mission to not just loan money and collect interest, but to help the next generation get out from behind their debt so they can take on the jobs and start the companies we need to keep American industries competitive. Splash also acknowledges that different degrees come with different opportunities and loan amounts, so your application won’t be accepted or declined based on a simple algorithm.
In some cases, refinancing student loans with a company that specifically deals in student borrowing while consolidating other debts elsewhere might be the right choice. It adds a few more steps to the process, but you need to keep the end goal in mind: pay less in monthly fees.
Since lending makes up such a significant part of the economy, finding someone who targets your specific type of debt shouldn’t be too hard. Whether it’s business debt from a small farm or lingering personal debt from a string of bad luck, you should be able to track down a lender with experience relevant to your situation.
You can get a personal loan from anywhere to cover anything. This category is exceptionally broad making the pros and cons equally sweeping.
The biggest plus is probably the availability. Whether it’s your bank, a crowd-funding site, or your Aunt Florence, you can find a way to get a loan. If you’re able to get a loan from your bank for the amount you need, that can streamline the consolidating process since the money will go straight into the account you need to make payments from.
The peer-to-peer lending option shouldn’t be overlooked, as LendingClub, Kabbage, SoFi and a thousand other companies are ready to source your loan from a huge number of investors. If you need a relatively small amount of money, this avenue might be the best choice. Larger lenders don’t want to waste time giving a paltry loan with a good interest rate, but a handful of risk-averse investors lending to numerous borrowers like yourself won’t mind.
Finally, a loan from within your family or immediate community could have you paying next to nothing, other than offering endless gratitude to whichever uncle or cousin takes on your burden. It might not be comfortable asking for money to cover debt, but lots of people understand that one person’s financial freedom helps the community at large.
For all the variety and flexibility of a personal loan, each option brings a host of issues to view cautiously.
With a bank, you might waste six months waiting for a loan to get approved, and in the meantime, you’re just sitting there paying the high interest rates that have you looking to consolidate in the first place. And if all you need is, say, eight thousand dollars, you might not even meet the minimum loan amount for some of the larger banks. The smaller, online banks will more readily provide a small loan.
Wherever you bank, be cautious about the type of loan and terms. Personal loans are very different from business loans, and debt-relief borrowing is very different from a refi on a house. You need the lowest rate possible, so don’t get sweet-talked by a banker who just wants you to take on more debt.
While peer-to-peer lending offers an awesome forum for borrowing small amounts and getting very specific funding, a lot of these loans have brutally high APRs. The rate you get will depend on your credit score and debt-to-wealth ratio, of course, but anything about your status that raises red flags can send your interest rate from 5% to 25% in a hurry.
Debt consolidation is one of the primary uses for peer-to-peer lending sites, so it’s definitely worth a look. Just know that your might not get approved for the low rate you want/need.
Finally, with a personal loan from a family member, just be careful not to treat the exchange too casually. Make sure to sign a contract and set firm guidelines for repayment. Things get sticky in a hurry when one party feels like the other isn’t holding up their end of the deal, and the last thing you want is to shift your debt to a personal relation and then end up in small claims court.
The idea of opening up a new credit card for the sole purpose of taking on debt makes the hairs on my neck stand up a little. After student loans, credit card debt is the big killer of financial dreams, and swapping one for the other isn’t necessarily a good move.
However, part of the reason credit cards snare so many people is they offer such alluring benefits and introductory rates. Some, like Discover, target people who need to transfer balances and will provide 0% APR for something like 72 months. If you’re responsible with your payments, three years without interest can give you a great headstart on reducing those balances.
Many of you might already have a low-rate credit card on which you can consolidate at least of few other debts. For those of you who have fancy rewards cards, you might need to look at something more boring if you want to use it for consolidation. With any card, you’ll probably have to deal with a balance transfer fee, especially if you have a zero APR promotional deal, so make sure the size of your consolidation doesn’t force you to spend hundreds or thousands extra just to consolidate.
Responsibility always plays a key role with credit cards. These companies prey on those who lack self-discipline and spend money they don’t have. If you get lured in by an interest-free grace period and then aren’t able to pay off your debts within that window, you’ve fallen right into the creditor’s trap and might be worse off than when you started.
Conversely, if you can do the math and figure out how much headway you can make with a lower APR over a two-year span, moving student loans and other credit card balances to a card with better rates might save you thousands in the long run. Bottom line: you need to have a plan.
Unfortunately, a few people will read this article and get really excited about managing their debt, then find out consolidation isn’t even an option. At a certain point, your debt becomes too overwhelming and a better interest rate is no longer on the table.
In theory, if not in practice, consolidating debt needs to be a preventative measure. Instead of waiting for monthly payments to become so crippling you don’t know if you can afford rent, you should try to pack your loans under one umbrella while you’re still slightly ahead. Even a physician making good money and easily making loan payments should consider how loan consolidation could speed up the reimbursement process.
With bad credit - which is often a result of too much debt - comes an inability to improve your rate. There might still be lenders willing to give a brief introductory rate if your FICO score isn’t abysmal, but it’s pretty tough finding a good consolidation plan after your credit takes a big hit. The only option is to slowly climb out of the hole and, as your credit improves, so will your chances of finding ways to pay down your debt more quickly.
Don’t wait for debt to become suffocating. When you have decent credit and steady income, lenders will fall over themselves to give you money, so you might as well take advantage and consolidate early. Consolidating could keep you from falling on hard times; it could be the thing that helps you survive when hard times hit; or it might just save you a few hundred dollars a month. In any case, if you have the option to combine loans and pay less in interest, there’s no reason not to improve your situation as a borrower.
If you do a little research, you’re bound to find a half dozen debt consolidators you’d never heard of before. Some can help you and others cannot, but it’s worth looking into your options and turning a handful of annoying debts into one consolidated loan you can pay back more quickly.
Most importantly, don’t immediately go with the first option. Compare, contrast, and see if you can find a lender with a good understanding of your debt, career goals, and overall situation. The right loan from the right provider can make all the difference.