How Does Debt Consolidation Work?

It’s time to take a good hard look at your finances and stop from drowning by discovering how does debt consolidation work and is it right for you.

Are you drowning in debt? Are you overwhelmed by your finances? It’s common to feel like you’re so buried by debt that there’s no way out.

That’s where debt consolidation can help. The first step to getting out of debt is to stop spending and take a look at your finances.

Where can you cut back? Where are you over-spending? Is there a way to pay off your debt while still covering your day-to-day expenses?

Debt consolidation can help answer these questions and get you on a better financial path. How does debt consolidation work? Let’s find out.

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What is Debt Consolidation?

It’s essential to understand that debt consolidation doesn’t erase your debt. However, with bill consolidation, you can get a handle on how much you owe and simplify how you pay it back.

Consolidating debt combines more than one unsecured debts into one monthly bill. These debts can include:

Credit cards
Payday loans
Taxes
Medical bills
Utility bills
Other past due bills

To consolidate these payments, you take out a larger loan or a new form of financing that covers the total amount of your separate bills. You pay one bill each month over the course of the new financing that pays off your smaller debt amounts.

What Does Debt Consolidation Look Like?

Taking out a new, larger loan to pay off smaller loans might not seem like a great idea. If you’re trying to get out of debt, why add more debt?

There are several approaches to consolidating different kinds of debt.

A New Credit Card. Do you have several credit cards with an outstanding balance and high-interest rates? One way to get a handle on credit card debt is to transfer the balances of several cards to one new card with a lower interest rate. Make one monthly payment at a lower rate to get out of credit card debt.
A Debt Consolidation Loan. Some creditors offer debt consolidation loans for bad credit. This type of loan is only for paying off debt, like student loans, medical bills, or credit card debt. In most cases, you’ll find lower interest rates for debt consolidation than other types of loans or credit cards. However, if you have bad credit, you’ll end up with higher interest rates.
A HELOC or Home Equity Loan. If you own a home, you can use your home as collateral for a home equity loan. This is a popular option because you can often use the payments as a tax deduction. However, be careful using your home as collateral for any loan. If you default on the loan payments, your creditor can take your house.

Before consolidating your debt, be sure you’re aware of the risks. Debt consolidation can be a good way to stop the cycle of increasing debt. However, it’s not the best solution for everyone.

Should I Consolidate My Debt?

When considering debt consolidation, make sure you do your research. It can be the right tool for some, while others could need a different type of plan for debt management.

When It’s a Good Idea

A debt consolidation loan or credit card can be a good option if you have good credit.

With a high or above-average credit score, you can qualify for better interest rates on your consolidation loan or a credit balance transfer card. Lower interest rates help reduce your monthly debt payments, which helps decrease your total debt payout over time.

Be sure you can also break bad habits. If your debt is a result of over-spending on credit cards, your debt consolidation loan should come alongside your commitment to change your spending habits.

When It’s a Bad Idea

If you have bad credit, debt consolidation might not help you in the long run. Consider other options for managing your debt.

With a low credit score, you have limited options for a low-interest rate loan or credit card. If you’re not lowering your overall monthly debt payout with a consolidation loan, you’re not improving your debt situation.

A high-interest loan can add more debt to your finances over time. Never trade in one debt for another debt situation that sends you deeper into a bad financial situation.

What Else Can I Do?

If debt consolidation isn’t the right solution for you, work with a company to help with debt settlement.

These companies work with your creditors to reduce or cancel the debt. With medical debt or student loan debt, having an advocate to help reduce the amount you owe can be a big help.

These services usually require a fee to settle your debt, and they can’t promise total cancellation of everything you owe.

Be aware that debt cancellation can lower your credit score. But, it can be a viable solution if bill consolidation isn’t right for you.

Do Your Research

Before moving, consolidating, or canceling your debt, do your research.

Read the fine print that applies to any debt consolidation loan, HELOC, or balance transfer credit card. Make sure you understand the fees, payment schedule, and penalties for defaulting on your payments.
Investigatecreditors and debt cancellation companies before committing to anything. Look for reviews from others using these companies. If they offer terms or options that seem too good to be true, they might not be the right solution for you.
Make a plan to avoid future debt. How did you end up with so much debt? What can you change going forward? Examine how the debt became overwhelming and document a better path forward.

Reduce your amount of debt in a way that makes the most financial sense, then work to stay debt-free.