What You Need To Know About Debt Consolidation
[Editor’s Note: Today’s article in a guest post from Ryan Luke who blogs over at Arrest Your Debt. He’s been a cop for 15 years and has seen the devastation left behind by people who mismanage their finances. This is what motivates him to help others become debt free..]
Take it away Officer Ryan…
If you have many different debts with different interest rates, payoff
schedules, and balances, it may sound like a good idea to sign up for
debt consolidation. Debt consolidation can seem appealing with the
promise of a significantly lower monthly payment and a reduced interest
For some people, debt consolidation may be a reasonable solution. For
others, they will be making the debt consolidation company rich.
The truth is, debt consolidation and debt relief salesmen will tell you
whatever you want to hear to get your business. Don’t fall for any of the
gimmicks or false promises. Before you sign on the dotted line, learn the
truth about debt consolidation to find out if this strategy is right for
What Is Debt Consolidation?
Debt consolidation is the process of combining all of your debts into one
single debt. If you have different loans out with varying rates of
interest, the consolidation will give you one interest rate and one lender.
This can often result in a lower interest rate and a single payment each
month. By combining all of your debts into a single loan, it can be easier
to keep track of your payment schedule.
Debt consolidation can combine auto loans, high-interest credit card
balances, student loan debt, and medical bills separately or all together.
This is accomplished by taking out a new loan or combining debt onto one
credit card that will take over all the existing loans.
How Does Debt Consolidation Work?
If you find yourself with payday loans that are spiraling out of control in
conjunction with your vehicle loan and high-interest credit card balances,
it may seem like a good idea to apply for debt consolidation.
Debt consolidation can stop the ballooning interest rates and fees of a
payday loan. Debt consolidation does this by paying off your balance in
full with another loan and restructures your debt that you will repay to
While this may seem like a great idea, there are some additional facts you
need to know about debt consolidation that we will discuss further in this
article. Debt consolidation will often add fees and other taxes onto your
existing balance and will also add more time to your debt payoff.
Ways To Get A Debt Consolidation Loan
There are several methods to consolidate your debt. All of the ways to
secure a debt consolidation loan depend heavily on your current credit
Zero Percent (0%) Interest Cards
Depending on your outstanding debt, you may be able to transfer all of your
outstanding debt to a 0% interest credit card if the card limit is high
enough. Some people will transfer their outstanding debts to several 0%
interest credit cards and play the shuffle game as they slowly pay off
their debt on each card.
Keep in mind, most 0% credit cards have a transfer fee for moving
outstanding debt onto the card. Also, 0% credit cards have a time limit to
when the 0% expires, and the regular interest rate kicks in.
After the 0% interest time frame, your interest rate could jump to over 20%
if you are not able to pay the card off in time.
You should avoid this dangerous game.
Private Loan To Consolidate Debt
Another method to utilize debt consolidation is to contact a lender,
usually a bank, and request a private loan. This loan would cover all of
the outstanding balances of the debt you would like to consolidate/combine.
You would use the loan to pay off all the debts and make one single payment
to your lender.
This is generally one of the best options to consider as long as you
utilize a fixed rate interest loan.
Debt Consolidation Companies
Many debt consolidation companies will handle all of the paperwork,
refinancing, and debt payoffs for you as well. These companies will charge
a fee that often gets rolled into the loan they provide.
Home Equity Line Of Credit (HELOC) Loan
Another strategy is to utilize your home as equity and combine your debt
into a home equity loan (HELOC). This process will also add additional fees
to the loan and will extend the amount of time it will take to pay off your
For instance, if you added $50,000 in outstanding debt to your home loan,
depending on your loan structure, you may have just signed up to pay off
the additional amount over 30 years. Even with a lower interest rate, the
added time will usually end up in you paying much more than you would have
if you would have paid the debt off using a snowball or avalanche method.
401k, 403b, 457 Loans – Borrowing From Your Retirement Plan
Depending on your current retirement plan, you may be able to take a loan
from your 401k, 403b, or 457 retirement plan. These plans have strict rules
as to the amount you can borrow and generally allow you to take a loan out
up to $50,000 or half of your total retirement portfolio, whichever is
For a detailed explanation of whether you should consider this
option, refer to my related article,
Is It Smart To Borrow From My 401k To Pay Off Debt?
Does Debt Consolidation Work?
Several people have asked me if debt and credit consolidation works. This
is a generic question that requires much more insight and explanation to
answer. For this broad question, the simple answer is, “yes,” debt
consolidation does work to combine all of your outstanding debts into one
This single loan may often have a lower interest rate and can lower your
monthly payment. However, debt consolidation may cost you more money in the
long run, depending on your situation.
Debt consolidation does not guarantee that it will save you any money even
though you may have a lower interest rate and lower payment.
Debt Consolidation Example Scenario
Below is a graph of debt consolidation scenario for someone who wanted to
consolidate $35,000 worth of debt. I used the debt payoff calculator on Credit Karma
for these numbers.
As you can see from the graphic, even with a lower interest rate, the added
time and the origination fees can add up quickly. Time is not on your side
when it comes to paying off debt.
Besides, if you plan on paying off the consolidated debt faster, some loans
have prepayment penalties.
payments, you will incur additional fees.
Always read the fine print!
What Is The Average Debt Consolidation Interest Rate?
ValuePenguin did a study on debt consolidation interest rates and found that the rates
vary significantly. The rate depends heavily on credit score but also
differs by company.
Here is the data they found:
- Excellent (720-850)
- Good (680-719)
- Average Or Fair (640-679)
- Poor (300-639)
Average Interest Rate
- 4.52% – 20.57%
- 6.67% – 28.33%
- 7.05% – 30.32%
- 15.06% – 36.00%
How Debt Consolidation Impacts Your Credit Score
Debt consolidation can impact your credit score in several different ways.
Throughout the process, your score can change for the better or, the worse,
depending on your circumstances.
Ways Debt Consolidation Can Hurt Your Credit Score
- When you initially apply for new credit cards or personal loans (to
include a HELOC), your credit score will drop until you start making
payments to the new lender.
- Your credit score will suffer if you continue to accumulate more debt
after you have consolidated.
- If you apply for a personal loan or with a debt consolidation company
for relief and you get denied, your credit score will take a hit.
- After you have obtained a debt consolidation loan or contract, if you
are late on these new payments, your score will be negatively impacted.
Ways Debt Consolidation Can Improve Your Credit Score / FICO Score
Debt Consolidation And Debt Settlement Programs Are Very Different
As we discussed earlier, debt consolidation moves all of your bills into
one single payment and lender with a fixed interest rate. A debt settlement
program relies on a company to work on your behalf to reduce your debt.
What Is Debt Settlement?
A debt settlement program involves a contract with a company that will
negotiate with your lenders with the hope of reducing the amount of money
you need to repay. These companies will charge you a fee for their services
and take over your debt repayment.
Debt settlement companies advertise that they can quickly help you become
debt-free and avoid bankruptcy by reducing debt so you can pay it off
sooner. However, there are no guarantees debt settlement companies can
lower your debt. The lenders are in charge and are not required to settle
any of the liabilities for less than the full amount owed.
How Does Debt Settlement Work?
There are several strategies that debt settlement companies use to
negotiate with debt collectors. Some methods utilized are:
- They may stop paying on your credit cards or loans to pressure the
companies to settle your debt.
- Debt settlement involves contacting the lender in an attempt to
negotiate a smaller balance. Debt settlement companies will do this on
- If the debt settlement company is not successful in reducing the debt, as the borrower, you will be responsible for any late fees the lenders
- Very few debt settlement companies can guarantee anything and are
heavily governed by the Federal Trade Commission due to scams involved.
- Stopping payment on debt and incurring late fees will negatively impact
- If any of your debts are settled and reduced, this will be reflected on
your credit report as settled, and any unpaid debt may show as settled.
In reality, debt settlement can be done by you without the help of a debt
settlement company. For more information, check out my related article, How To Negotiate With Debt Collectors!
Due to the number of scams and lack of guarantees, you should avoid debt
settlement programs and companies at all costs. Anything they offer, you
can do on your own without paying them high fees and destroying your
So, Is Debt Consolidation A Good Idea?
If you have mountains of debt with different interest rates and different
lenders, you need to consider all the pros and cons of debt consolidation
before you make a final decision.
Pros Of Debt Consolidation
- Debt consolidation can significantly lower the interest you are paying
by moving the balance to a 0% interest card or a lower interest rate
- Debt consolidation can help simplify your debt repayment by giving you
one lender to pay rather than many different lenders each month.
- It can reduce your monthly payment on your total outstanding debt.
Cons Of Debt Consolidation
- Additional balance transfer fees will be added to your total amount of
- Debt consolidation can increase the amount of time it takes to get out
of debt by adding additional years before you are required to pay off
- Your credit score (FICO score) can be hurt by applying for new loans.
- A lower interest rate with extended time to repay the debt can cost you
more money in the long run than if you had paid the debt off without
- If you have a spending and budgeting problem, debt consolidation will
not help your underlying issue.
The Best Option If You Are Considering Debt Consolidation
Debt consolidation and debt settlement will come with additional fees and
will often add a significant amount of time to your debt payoff plan. The
lower payment and interest rate gives you the illusion of saving money, but
in reality, you are adding more time and more money to your debt.
The immediate relief you receive from a lower payment can be quickly erased
if you have not put a plan together to get out of debt and stay out of
There are very few cases where hiring a debt consolidation service makes
sense. If you have an incredibly high-interest rate, it may make
mathematical sense to refinance if you commit to paying the same amount or more off each month. Lowering your payment will help you pay the loan off quicker by
paying more than the required amount (if the loan does not have a
A Debt Management Plan
- Create a budget
- Build a savings account structure
- Start an emergency savings
- Pay off your debt with the debt snowball or the debt avalanche method
With patience, persistence, and by following the above plan and links, you
will be able to get out of debt. The biggest challenge is maintaining
discipline and a commitment to changing your lifestyle.
Bill consolidation or settlement is a “quick fix” that usually does not end
well. These programs make other people money while giving you the illusion
of saving money.
Save money and time by getting out of debt the right way – through hard
work, determination, and a plan.
This article originally appeared on The Money Mix, and has been republished with permission.