When looking for ways to get out of debt you may get confused with what debt consolidation programs can offer you. Companies giving loans to pay off debt will tell you it’s a consolidation loan. Other agencies offering programs or plans to pay off debt without using a loan claim it’s a consolidation program.
Each consolidation service tries to make you believe that their offerings are better than the other. To make matters worse, there are fraudulent companies that take advantage of the confusions by enticing consumers who are actually not right for their debt consolidation programs, making them financially worse than before they join the plans.
Is debt consolidation a good idea? Will a debt consolidation program helps or hurts? How do you find a reputable company to work with in the sea of different consolidation services? Continue reading to get thorough answers below.
What is Debt Consolidation?
Debt consolidation entails taking out one loan to pay off many others. This is often done to secure a lower interest rate, secure a fixed interest rate or for the convenience of servicing only one loan. (Wikipedia)
Debt consolidation involves combining several unsecured debts into one, lower monthly payment than the total amounts paid individually. (DebtFirms)
How Debt Consolidation Programs Work?
Depending on your financial status there are 3 debt consolidation programs that will work for you. They are an unsecured loan, a secured loan and a debt management plan. Take a look at how all the debt consolidation programs work, including the risks and the benefits here:
- An unsecured loan. An unsecured personal loan probably has the lowest risk compared to the other options. You can get a personal loan from your bank or credit union to pay off your creditors. To qualify for a loan you must have a good credit score and your debt to income ratio is within a low range.
- A secured loan. If you own a home with a significant equity, you may be able to consolidate your debt through a home equity loan or equity line of credit. Compared to other programs this may offer you the biggest saving and your credit score will not be affected as well. But you have to weigh the benefits with the risks of losing your home for non-payments.
- Debt management plan (DMP). Enrolling in a debt management program through a credit counseling agency is another debt consolidation method. This is an option to take if you can’t get an unsecured loan and you don’t want to risk your home for a secured loan. You will also learn about credit management from a certified debt counselor and he or she will help you build good money habits as well.
What are Your Debt Consolidation Options?
There are other debt consolidation programs that apply to a specific type of debt and a specific financial situation as well. The options are included here because they still fall under the “combining several unsecured debts into one” definition. Take a look at how these debt consolidation programs work, including the pros and the cons below:
- Self help debt management with a loan. If you’re current on your bills and have good credit, try to get a consolidation loan. With the loan in hand tell your creditors you want to pay off their bills in one lump sum in an exchange for them to reduce your debts. But there are risks that the creditors won’t agree with your proposal and, as a result, the saving that you can get may not be as attractive as what you’ve expected.
- Credit card balance transfer. If you have high interest credit card debt and your credit score is good, try to find 0% interest or low APR balance transfer offers. Make sure to take a look at things such as length of introductory period, transfer fees and other factors before getting one. Also, compare the total costs with your current credit cards to really lower your monthly payments.
- Debt settlement program (DSP). This debt consolidation program is an option to consider when you have fallen behind on your payments and those late and non-payments affect your credit scores negatively. This is especially true if you find it difficult to pay off your minimum payments but you still have small income that allows you to accumulate cash to pay off a percentage of all your debts.
What is the Best Way to Consolidate Debt?
Check all the above debt consolidation programs and find what methods you can qualify for. The higher your credit score is the higher your chance to qualify for more than one plan. According myFICO, people with good to excellent credit, on average, only use 7% of their credit limit. This means you will only be qualified for an unsecured consolidation loan or a low-interest credit card if you have a good credit score and a low credit utilization.
If your FICO score is below 620 things can get tough. You won’t be able to get a prime loan. There are consolidation loans for bad credit but they are harder to get. Also, you have to check whether the rate will be lower than the rates of your existing debts. In such a situation it’s good for you to talk to a credit counselor to find out whether a debt management plan can help.
When your income can barely cover the monthly minimum payments and you’re considering filing for bankruptcy a debt settlement program may offer you a way out. However, if you have no income or assets to cash out and you can’t reach a debt settlement agreement with your creditors chances are bankruptcy is your only option.
Do Debt Consolidation Programs Hurt Your Credit Scores?
To understand how a consolidation program affects your credit you have to understand what makes up your credit score. Your FICO credit score is calculated based on five categories: payment history (35%), credit utilization (30%), length of credit history (15%), credit mix (15%) and new credit (10%).
When talking about debt consolidation there are two factors that affect your credit score: credit utilization and new credit. Credit utilization is the amount of credit limits you’re using on your credit cards. FICO score measures the amount owed with “credit utilization rate” — the ratio of your credit card balances and overall credit limits.
Now it depends on which debt consolidation program that you go with. If you take out a consolidation loan, that will increase your credit utilization. It will slightly impact your credit scores because the risk that you will default on a credit account is increasing plus you have a new account. This is especially true if you close some or all the credit cards you’ve consolidated.
A debt management plan will also have a slightly impact on your credit score because you have to close active accounts. As you have eliminated years’ worth of unsecured credit history within the plan you have to rebuild your credit history after completing it.
When you join a debt settlement program you must have missed some payments. The late and missed payments will reduce your credit scores significantly. This program also affects your credit score negatively and the only way to recover it is when your last account get settled.
How to Find the Best Debt Consolidation Companies
Once you decide the right debt consolidation programs for you try to find reputable companies to work with. For example, you may want to contact local banks or credit unions that offer loans to consolidate debt to compare their quotations and pick one with the best rate and term.
Depending on your credit score, credit utilization and other factors qualifying for a low-interest consolidation loan is often hard. But with a little work you’ll find a lender that want to offer you a loan at good rates.
If services like debt management or debt settlement are what you’re looking for, visit consumer review sites to find reputable companies you want to talk to. Before working with one of the companies check them with the BBB to see whether they have unresolved complaints. Also, talk to the company’s representative and ask critical questions. Don’t sign up with their debt consolidation program if you aren’t satisfied with their answers.
Remember, debt consolidation programs are just a tool for you to control your debt and make your repayments more affordable. Your goals are to pay off debt, rebuild your credit and, most importantly, develop good money habits.
What to Do Next?
Click Here to get reviews of reputable debt consolidation and credit help services, if you haven’t found a specialist to work with.
Fico Score infographic – http://www.myfico.com/
Will debt consolidation help or hurt your credit? – http://blog.credit.com/