Debt consolidation is the process of combining numerous smaller debts into one larger and easier-to-pay loan. The average American household that carries debt from month-to-month has $16,048 in debt, according to the U.S. Census Bureau and Federal Reserve.
And, more than 38% of households carry some amount of credit card debt. It's easy to become overwhelmed, frustrated, and downright worried about how you'll pay off that kind of debt.
Luckily, debt consolidation can provide a solution. With good financial habits, it's possible to work towards paying down your existing debt faster and with less cost. The key is to consolidate in the right manner and with the right resources. Whether you use a debt consolidation loan or a larger credit line, there are a few things to keep in mind to ensure you have the best level of success possible.
1. Start with a Credit Report
Before you approach a lender to inquire about debt consolidation, you need to know how much debt you already have. Though checking each of your credit card and personal loan balances is important, it is just as important to look over your credit report for any missed or forgotten accounts. A number of free services are available to do this. You have the right to see your credit report, without charge, at least one time per year. This applies to each of the three credit bureaus.
To access your report, visit AnnualCreditReport.com. If you notice errors in your credit report, dispute the claim through the credit reporting agency. Equifax, TransUnion, and Experian each offer an online process for disputing information. Once your credit report is accurate, you can begin looking for debt consolidation options. This allows lenders to get an accurate picture of the type of borrower you are.
2. Create a Comprehensive Budget
Why do you need a budget when it comes to consolidating? A budget outlines income and expenses while shedding light on opportunities for saving and paying off debt. With the information from a budget, it's easier to see how much you can afford to pay each month towards debt. This information also helps lenders determine whether or not you are a good credit risk.
To create a budget, first, gather all information about the income you have each month. Then, write down each of the expenses you have. Include utilities, home loan payments, car payments, dining out – anything you spend money on each month. To help with this, look through old bank and credit card statements to gather accurate information about your spending habits. With this information, develop a budget for the coming month.
Based on your income, how much can you spend towards entertainment or dining out? How much can you allocate for paying off a sizable amount of debt each month? You will also be able to see how much of a monthly payment you can afford to make on a debt consolidation loan.
3. Consider Each of Your Debt Consolidation Options
Moving multiple credit card bills and personal loans into one monthly payment can help anyone's ability to manage finances. But, there are several options for borrowers to consider. You may wish to use one or more of these methods.
- Lower interest rate credit cards. Moving all of your higher rate credit cards to a new credit line that has a lower rate will save you a significant amount of money. This option is best for those who have good credit and solid income.
- For student loans, consolidation loans are available. These tend to be available for most types of student loan debt. If a lower interest rate is available to you, consolidating these loans into one makes sense financially.
- A personal loan for debt consolidation is another option. Though a bit more difficult to get, these loans can offer the largest benefit for those with considerable credit. An asset-backed loan, such as a home equity loan, is an option in some cases. However, consumers should carefully weigh the benefits and risks of moving unsecured debt to their home.
These are a few of the most common options available. For those with good or better credit, any option may be available. For those with less-than-perfect credit, it may be necessary to consider working closely with banks to find a credit builder loan.
4. Ask for Help
Some banks offer assistance through debt management services. There are numerous debt management companies out there as well. If you decide to use these services, remember a few things:
First, nonprofit organizations tend to be the best. Second, they cannot do anything you cannot do on your own. Finally, and perhaps most importantly, using a debt management company can lead to a ding on your credit report that can remain for some time. Use this option as a last resort when you simply cannot find a loan or credit card for debt consolidation.
Debt management companies work simply by closing your accounts and negotiating a lower monthly payment from each lender. The lender agrees only because you may be a high-risk borrower.
5. Compare Terms and Options Carefully
For most people, debt consolidation loans are very much available. Even if you decide to use a credit card for consolidation, you'll have options to choose from. Don't be afraid to ask your lender for the best possible rate – not all offers are the same!
- Interest rates often matter most. Because this is a larger sum of money, it's important to keep interest as low as possible. Compare options by interest rate as a primary factor.
- What's the monthly payment? Remember your budget? Be sure it is within your ability to make this payment on time every month. If a bit less will help make this possible, ask your lender for this benefit.
- Be sure you can repay your debt early. Look for a debt consolidation loan that does not have an early repayment penalty. The sooner you pay off the loan, the more you'll save.
6. Stop Using Your Old Credit Cards
Once your debt transfers to the new line of credit through consolidation, your existing credit cards will be paid off through the new loan.
- Don’t run up the debt on these cards. Put them aside and don't use them.
- Don’t close them – that could hurt your credit score.
- Don’t forget that those with annual dues may have a payment at some point due.
7. Make Your New Payment On Time Every Month
With your new debt consolidation loan or credit card in place, you'll be able to set a new precedent for your future credit use. That is, by making payments on time every month, you'll be able to rebuild your credit. This provides the opportunity for a good credit score and better borrowing power down the road.
By using these tips, anyone struggling with debt can find an opportunity to get out of the financial hole. Take the time to really look at all of your options. Create a budget that's very accurate. And, it may mean cutting a few meals out or not picking up that coffee every morning, but the rewards will be worthwhile even right away.