This post is the third in my series on knocking out chores to get your financial house in order.
What’s the best way to consolidate my debt?
Should I try debt consolidation?
Where can I get a debt consolidation loan?
It's not unusual for someone in debt to be making five to eight payments each month just to credit card companies. In that sense, debt is a lot like clutter. Even when you manage to make all the payments each month, it takes up an enormous amount of mental and physical energy just to keep up.
DebtConsolidationCare.com, which offers free advice to consumers with debt consolidation questions along with a free debt consolidation calculator, lists eight benefits of debt consolidation, including a single monthly payment, reduction of interest, and stopping collection calls. All of those benefits lead up to the ultimate goal, however, which is to get out of debt. If you keep that goal in mind, it will be easier to make a choice about which option to pursue.
I’ll list debt consolidation options in a moment, but before I do, I'd like you to ask yourself three things:
- How much do I owe? It sounds like an obvious question, but you’d be surprised how easy it is to lose track of the totals when you’re overwhelmed financially.
- How strong is my credit score? Some consolidation methods will affect your credit scores more than others. Before you start, you need to be realistic about where your credit stands now. Don’t assume that it's strong because you are making your monthly payments on time. Read my previous post on how to get your credit reports and scores.
- How motivated am I really to get out of debt? This is an important question. Some people will do whatever it takes, while others aren’t willing to go to extremes. You have to be honest on this one. If you have a partner, he or she has to be on board with you. At a minimum, you’ll have to follow a basic budget.
Once you’ve answered these questions honestly, the next step is to look at the options. Since this is a blog post, and not a debt consolidation book, I am keeping it brief here. You can get many more details, including help with your individual questions, at DebtConsolidationCare.com.
If you enroll in a Debt Management Program (DMP) with a credit counseling agency you’ll make one monthly payment to the counseling agency which will in turn pay each of your participating creditors. You’ll be out of debt in five years or less.
The downside? You’ll close all your credit cards, and that will affect your credit scores (though not as much as you may expect). The biggest challeng will be to stick with the payment schedule each month or you could wind up falling out of the program and starting all over again.
Debt Consolidation Loans
Get a loan and use it to pay off all your other debts, then make one monthly payment to your new lender. Ideal right? The problem is, the more you need a consolidation loan, the harder it is to get one. Many banks don’t even make small unsecured consolidation loans anymore.
You may need to turn instead to a social lending service. My colleague Beverly Harzog, who co-authored The Complete Idiot’s Guide to Person-to-Person Lending with Curtis Arnold, reports that peer-to-peer lending is making a comeback, but you’ll likely need excellent credit to qualify. (You checked your scores, right?)
A friend or relative may be willing to give you a consolidation loan, but be sure to write up a loan agreement and take it seriously. Otherwise, just be honest and ask for a gift.
The downside: If you are able to get a debt consolidation loan at a decent rate, it may be easy to fall into the trap of using the credit cards again. And if you don’t stick with a spending plan, the consolidation loan will soon become just another monthly payment.
Loans Against Retirement Plans
Borrow the money you need to consolidate from your 401(k), 403(b) or pension plan. (You cannot borrow against an IRA.) No credit check is required. You must pay back the loan over five years, and you’ll pay it to your own retirement account. That means the interest you pay will, in effect, be to yourself.
The downside: The monthly payments may be higher than what you’re paying on your credit cards, which means you may find yourself turning back to the plastic again when money is tight. And if you can’t keep up with the payments, your loan may be treated as an early withdrawal, which means you have to pay taxes and a 10% penalty.
Other alternatives to debt consolidation:
If the above options don't appeal to you, or don't work for you, get a little more creative.
Bankruptcy: While it may seem like the most drastic step, sometimes it’s necessary. Just don’t wait until you are about to lose your house or have drained all your retirement savings to talk with a bankruptcy attorney.
DIY Consolidation: Your credit card statements list a dollar amount you must pay each month to pay off your balance in three years. Set up automatic withdrawals from your bank account for that amount, and put your credit cards away so you can’t use them. If you get any extra money – a tax refund for example – throw it at your debt with the highest interest rate. You’ll be debt-free in three years or less.
Have you consolidated debt successfully – or not so successfully? I’d love to hear from you. Use the comments section below to share your story.
Gerri Detweiler’s mission for the past two decades has been to provide consumers with reliable answers to their credit questions. She serves as personal finance expert for Credit.com and shares her knowledge at several websites including DebtConsolidationCare.com and AllBusiness.com. She is the author or co-author of five books including Reduce Debt, Reduce Stress: Real Life Solutions for Solving Your Credit Crisis.