Debt Consolidation

How Does Debt Consolidation Work?

how does debt consolidation work

Debt consolidation can offer you the satisfaction of cleaning up a stack of monthly bills by rolling several debts into one. This makes managing your bills easier, but does debt consolidation work? The answer depends on your goals for rolling your consumer debt into one account with one payment. Your results can vary according to the type of debt consolidation you use. There are pros and cons for each type.

Debt Consolidation Options

Credit card balance transfers:

Chances are if you have good credit, you’re familiar with balance transfer offers. A credit card company solicits your business by encouraging you to transfer balances on other credit cards to their card. Typically, you’re offered a period of no or low interest as an enticement. But the bank offering the transfer typically charges 3 to 5 percent of each amount you transfer as a “balance transfer fee.” The Federal Reserve advises consumers to pay close attention to fees charged when shopping for a credit card. This takes a bite out of your potential savings, but if you have a few small balances on high cost consumer credit cards, rolling them into one credit card balance with a low rate can help you save, especially if you can pay off the entire amount transferred during the low or no interest introductory period. If you are tempted to spend impulsively, opening a new credit card to transfer balances can be risky if you use the credit card for additional purchases after transferring your balances.

Personal loans for debt consolidation:

Financial institutions may offer personal loans (also called signature loans) that you can use to consolidate debt. Not to be confused with payday loans, a personal loan is typically offered for a specific period with set payments and a fixed interest rate. The rate you’ll pay for a personal loan depends on your credit scores, but it can be worthwhile to use a personal loan to consolidate high cost consumer debt, such as retail credit cards or medical bills, that are headed for collection. A personal loan does not provide access to additional credit, so you can’t be tempted to spend more than you borrowed for debt consolidation.

Personal line of credit:

This is a type of personal loan that provides a credit line that you can draw against to consolidate debt or for other purposes. Personal credit lines typically have adjustable rates that are attached to a specific financial index. This can make calculating your potential savings more difficult, as your interest rate on your personal credit line is subject to change. A great benefit of personal credit lines is that you pay interest only on amounts used, but if you consolidate all of your debt and still have credit available, it can be tempting to “treat” yourself using the credit line, especially if you like to shop.

Home equity loans and lines of credit:

The Federal Trade Commission advises consumers against borrowing against their home equity for debt consolidation as home equity loans and lines of credit are secured by your home and can be foreclosed if you fail to repay. If you have a significant amount of home equity and a definite plan for repaying a home equity loan or line of credit, home equity loans and lines of credit can help you consolidate debt. As with other types of debt consolidation, you risk taking out a home equity loan, consolidating debt, and later incurring more debt if you don’t change your spending habits. In the case of home equity loans, this can be doubly risky as you’ll have increased the amount mortgaged against your house and your consumer debt.

Does Debt Consolidation Work or Not?

The answer to the question depends on your circumstances and goals. Success with debt consolidation is also dependent on your spending habits and how you got into debt in the first place. Compulsive spending can lead to more debt. If you’re struggling with debt, please consider consulting a certified credit counseling agency for help. The Consumer Financial Protection Bureau notes that credit counseling agencies may work as for-profit or non-profit agencies and that they usually charge administrative fees for their services. It’s a good idea to compare services provided and costs charged by credit counseling providers.

Shop and compare debt consolidation options to determine which option best meets your needs. Once you’ve chosen a debt consolidation option that works for you, you can shop and compare debt consolidation quotes to find your best lender and loan.

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