Debt Consolidation Loans for Bad Credit

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Overcoming debt with bad credit

Trying to pay off debt is a noble goal. But, if you’ve got multiple balances with multiple creditors, including some high-interest debt, it can feel like you have a mountain to climb that will take forever to be paid off.

When that’s the case, a debt consolidation loan may seem like a great option to lessen the interest rates and the number of payments you have to make every month. By transferring your various debt balances into a single loan, you can simplify the management of that debt and often get a lower interest rate. (To determine if you can lower your debt payments by consolidating, use LendingTree’s debt consolidation calculator.) Qualifying for a debt consolidation loan may be easier said than done.

If you have a giant mountain of debt, your credit score may also be less than stellar.

When debt consolidation is used as part of an overall commitment to reduce debt, it can be a key ingredient for improving your credit rating. But having a poor credit score makes it difficult to qualify for a new loan. Luckily, there are some alternatives that you may be able to pursue.

Shopping around pays off

Before you apply for a debt consolidation loan, you should shop around for the best interest rates, lowest fees and terms for your situation. Especially if you have a credit score at or near 700, you may be able to qualify for a loan with better terms.

It’s also important that you ensure you can afford any debt consolidation loan you take on. The fees and penalties for late payments and non payments can be severe.

In addition to your credit score, some lenders will consider other factors to help you qualify for loans with a better term, such as your employment history and income information.

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3 Alternative debt consolidation options for bad credit

Home Equity Loan/HELOC

A home equity loan is a collateralized loan, which means you don’t have to have great credit to qualify.

According to Rosenberg, taking out a home equity loan to consolidate your unsecured debt, like credit card debt, is a great way to save money and get out of debt.

“A secured loan will have a much lower interest rate because the risk to the bank is lower,” Rosenberg said. “That will lower your monthly payments out of pocket dramatically right away and force you to pay off that debt instead of continuing to revolve it on a credit card.”

However, you need to have built up equity in your home in order to get a home equity loan. This means you’ll need to have paid down your mortgage significantly, or have increased the value of your home to have equity.

A risk to consider: If you default on a home equity loan, you could lose your home since it’s the collateral being used to secure the loan.

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Debt management plan (DMP)

A debt management plan isn’t the same as consolidating your debt, but it can still be an option to lower your payments and help you get out of debt.

Rosenberg says many banks are willing to work with customers to set up a debt management plan rather than receive nothing at all if they are owed money.

“If your bills are totally out of control and you want to avoid bankruptcy, a debt management plan is a good way to go,” he said. “If you’re willing to work with the bank, they’d much rather have that than have you declare bankruptcy so they don’t get anything at all.”

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Bankruptcy may be able to help you wipe the slate clean by absolving you of your debt obligations. But, you may also be required to liquidate the majority of your assets.

There are different types of bankruptcy that will have an effect on how much and what kind of debt can or will be discharged, as well as rules about liquidating your assets.

It’s important to note that some debt may not be able to be discharged during bankruptcy. For example, students loans are almost never forgiven during bankruptcy, so you’ll still be on the hook to pay back that debt.

Bankruptcy is also a financial blunder that will stick with you for years to come. Your credit score will be damaged, and the bankruptcy can be on your credit report for up to ten years. This could prevent you from taking out any new loans or credit accounts during that time. Our research has shown that after five years, about 75% of those with a bankruptcy on their record restore their credit scores to levels that are generally considered eligible for loans.

If you are able to take out a new loan or credit card, the interest rates you receive after bankruptcy will likely be extremely high, which means it will cost you far more money for anything you decide to finance.

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Stop the bleeding
Don’t take on more debt.

Debt consolidation loans can make debt burdens more manageable, but they will only help you improve your credit in the long run if you stop taking on new debt.

For example, a debt consolidation loan may help you pay off your existing credit card balances. With those balances zeroed out, you may feel the temptation to start using those credit limits again. However, this would mean doubling up on debt – you would still have to make payments on the consolidation loan, plus you would have a whole new set of payments on the fresh credit card debt. This not would not only add to your existing debt burden, but it could put your house at risk if you become unable to make payments on a home equity loan.

So, along with consolidating your debt, you need to commit to following better financial habits in order to improve your credit standing. This means following a budget that does not include taking on more debt, and making all your payments on time. The combination of consolidation loans and a change in habits can be the right recipe for better credit scores.

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