Budget Guides

Ultimate Guide to Consolidating Your Debt

When you’re carrying a heavy debt load, it may be hard to stay on top of payments, especially if your debts are spread out across several different types of credit cards and loans. If you’re looking for ways to make it easier to repay your debt, consider debt consolidation.

Consolidating your debts means your debts get transferred to a single lender. In turn, you’ll only need to make a single monthly payment to the one lender. And depending on your creditworthiness, when you merge your debts, you may qualify for a lower interest rate and lower payments.

"Because everything is in one plan, you’ll stay organized,” says Beverly Harzog, a credit card expert and consumer finance analyst for U.S. News and World Report. “It will decrease your stress level, and the lower interest rate will help you psychologically as well.”

Should you consolidate your debt?

In this guide, we’ll go over a few common options for debt consolidation, and walk you through, step-by-step, on how to go about merging your debts:

Credit Card Balance Transfer

If you have good credit, consider transferring your credit card debts into a single credit card. Ideally the credit card will have an introductory zero percent APR for the first year.

As you may imagine, if you have less-than-stellar credit, you may not qualify for these types of cards. If you do, you may not be eligible for the type of interest rates and terms needed for the transfer to make financial sense.

How do you set-up a credit card balance transfer?

1. Tally up your debts. This include the amounts owed, interest rate, monthly minimum payments, lender, and repayment period. If it’s been a while since you’ve checked in on your debts, you’ll want to double-check all the information before hunting for a credit card.

2. Order a credit report and check your score. You can get one free report from each of the three major consumer credit card bureaus—TransUnion, Equifax, and Experian within a 12-month period. Because you’re entitled to a free report per year, you can order a report from one of the three bureaus, and save the other two for later use. You can get a order a report for free from AnnualCreditReport.com.

After you receive your credit report, carefully check all the information for accuracy. One area you’ll want to pay close attention to is your accounts and payment history. It could throw off your repayment plan if the information is inaccurate. If the information is inaccurate, you’ll want to file a dispute. The bureaus typically have 30 days to look into your claim.

Read more: How to Locate and Correct Errors on Your Credit Report

You can order a credit score, or check it from a free credit monitoring service. These days a lot of money management apps and credit cards offer consumers their credit score for free. Note that there are multiple credit scoring models out there, so the score you get may be a hair different than the FICO® or VantageScore® from a credit card bureau.

3. Shop around for credit cards to see which ones you qualify for. When you do a credit card balance transfer, you’ll also need to ask for a high enough limit to cover the balance from multiple cards, points out Harzog.

Let’s say you have three credit cards. Card A has a balance of $5,000, Card B has a balance of $9,000 and Card C has a balance of $2,000. So the limit of your transfer credit card needs to be $16,000. As your total balance is $16,000, the limit on the card you’re transferring all your existing balances to must be high enough where it doesn’t hurt your credit utilization ratio (this is the percent of available credit that you’re currently using. Ideally, you want to keep this figure below 30 percent if possible).

How to calculate your credit utilization ratio

And you don’t necessarily need to qualify for a zero APR credit card. If the interest rate is lower than that of your other credit cards, it will save you money. For instance, if the lowest interest rate on your existing credit card is 20 percent, if you qualify for an interest rate of 10 percent, or even 15 percent, it will save you money, explains Harzog.

4. Apply for a credit card. This is a hard pull, which means it could negatively impact your credit score. Be cautious when applying for new credit. 

If you have less-than-stellar credit, the best option for debt consolidation for those with poor credit may not be debt consolidation period. It might actually be a debt management plan.

5. Aim to pay off your balance within the introductory period. If you don’t pay off your debts within the introductory period, you’re stuck with the normal interest rate for the remaining payments. It could potentially be higher than the the interest rate of your old cards, so be very careful. Only make open a new credit card and transfer your balance if you’ve got a long-term plan to repay your debts.

6. Don’t accrue any additional credit card debt. If you’re tempted to continue spending on credit and creating additional debt, you may want to close your old credit cards. Before doing so, note that closing an account means it’ll lower your credit utilization ratio.

For instance, if the spending limit of your three old cards is $20,000, and the new card is $30,000, that brings your total spending cap from $50,000 to $30,000. And if you’re total balance is $10,000, your credit utilization will shoot up from 20 percent to 33 percent.

So it might be better to keep your cards open, practice discipline and not use your credit cards until you’re done paying them off. The key is being honest with yourself and choosing the option that best helps you reach your goal. It’s perfectly okay to admit to struggling with certain spending impulses - the key is adapting positively to those impulses.

Debt Consolidation Loan

Another way to consolidate your debts is by taking out a debt consolidation loan. You can consolidate your existing debt, whether they’re credit cards, medical bills, personal loans, or a payday loan. These loans are considered personal loans.

1. Create a list of your debts

The first step is to know what kind of loans you have, says Stephen Newland, an accredited financial counselor and host of “Find Your Money Path Show.” And just like with credit card debt, you’ll need to tally up the loan amounts, interest rates, repayment period, and lender. “By far the best thing to do that I’ve seen to break through this is to simply list out your debt balances, your interest rates, your monthly payment and how much longer you have left on the loan,” explains Newland. “Sometimes we think things are worse than they are until we get them on paper. Even if it’s bad, this exercise allows us to take some level of emotion out of it and just look at the facts.”

Key facts about your debts

2. Research your options

A local bank, credit union, and reputable online loan consolidator are places to explore your options. There are two main types of debt consolidation loans: secured and unsecured. Secured loans are backed up by some form of collateral, such as equity on your home. Unsecured loans, on the other hand, aren’t backed by collateral. Look closely at rates, monthly payments, loan length, fees, and if there’s a penalty for paying off your loan early (yes, this is a thing, sadly). Besides simplifying your debts, compare the terms and rates with your existing loans.

Ideally, the rates should be lower than what you’re currently paying. You may also select a debt consolidation loan that helps you lower your monthly payments. Keep in mind that this may lengthen your repayment period, which could lead to you paying more in interest throughout the length of the loan.

If you’ll pay more on the new consolidated loan, then you might want to ask yourself why you’re consolidating your loans in the first place, points out Newland. “Is it to reduce your monthly payments because you’re having trouble paying it each month?” says Newland. “If so, then ask yourself if you’ve exhausted all other options, such as cutting expenses or finding extra work?”

3. Come up with a repayment plan

Before you take out a debt consolidation loan, figure out how much you can afford to pay each month. This will help you decide what loan and repayment plan to go with. Look carefully at your budget, and see if there are any areas you can cut back on.

That will help free up some money so you can stay on top of your monthly payments on your new loan. You might want to find ways to rake in extra cash to put toward your debt repayment. This might be picking up extra hours on the job, doing side hustles such as ride sharing, tutoring, or babysitting.

4. Make an informed choice

There’s so much information out there that it can be paralyzing, points out Newland. “It feels like this impossible hill to climb for most people and that can create fear of moving ahead,” he says. And when researching options, beware of scams. Read reviews, and look up customer complaints on the Better Business Bureau or the Consumer Financial Protection Bureau. Red flags include asking for money during the application process. It should be free to apply. If you suspect something fishy, do a bit of sleuthing beforehand.

Signs of a debt relief scam

Debt Management Plan

A debt management plan (or DMP) is a slightly different take on the concept of consolidation. Rather than consolidating the debt, you're essentially consolidating the debt payments instead. In other words, you aren't paying off a collection of old debts and replacing them with a new one; you're making a single, consolidated payment that distributed to your creditors each month.

There are some unique benefits for using a DMP. They're usually administered by nonprofit credit counseling agencies, which means you receive financial education as part of the process. In exchange for working with a credit counseling agency, most creditors are willing to reduce the interest rate on your credit card account and waive certain late or over-limit fees.

A DMP is also designed to fit your budget, so payments need to manageable. Most DMPs are completed within 3 to 5 years. To begin a DMP you simply need to connect with a qualified credit counseling agency.

Read more: How to Get a Debt Management Plan

Go the DIY Route

If you decide not to consolidate your debt, there are some DIY ways to make it easier for you to keep track of your payments. For instance, try a debt repayment method:

Debt Avalanche Repayment Method

With the avalanche debt repayment method, you make the minimum payments on all your debts. Then you focus on aggressively tackling the debt with the highest interest rate. Once you’ve paid that off, you take the money you would’ve used toward paying off the first debt toward the debt with the next highest-interest rate, and so forth.

The pros of a avalanche debt method is that you’ll save on the interest. However, it can be hard to stay motivated, as it can take awhile to pay off that first debt.

Debt Snowball Repayment Method

Whereas with the avalanche debt repayment method you’re focusing on interest rates, with the snowball debt repayment method, you’re prioritizing your debts by the balance. And instead of starting with the largest balance, you start with the lowest balance of your debts. That way, you’re getting an early win.

Debt repayment - snowball vs. avalanche

Debt Blizzard Repayment Method

Avalanche and Snowball are the best known repayment philosophies, but there is a third option. Created by Harzog and as explained in her book The Debt Escape Plan, the debt blizzard repayment method is when you start by paying off the debt with the smallest balance first. Here’s the kicker: After you’ve paid off your smallest debt, you then tackle the debt with the highest interest rate, then work your way from highest interest rate to the smallest.

With the debt blizzard method, you get the best of both worlds: the psychological lift of paying off a small debt in the beginning while saving money on the interest, explains Harzog.

No matter which debt consolidation method you choose, you should know the risks involved. Understand the repercussions of not staying on top of payments. Debt consolidation can help simplify your debt repayments and save you money. But not being able to keep up with your repayment plan could ultimately put you in deeper financial hotwater.

Debt can feel overwhelming and scary, especially if you’re not sure what the right choice is for you. “Realize you don’t need to go it alone,” says Newland. “Reach out to a financial counselor, or seek out trusted resources that can help you process your unique situation.”

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