In a time when inflation has driven up costs of living significantly, more Americans rely on credit cards and other loans to keep up. When high interest mounts, it can be easy to fall behind.
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Debt consolidation is a method of getting out from under the burden of high interest to get ahead. While sometimes risky, depending upon the approach, in many circumstances it’s a better alternative than drowning in bills or falling behind.
Financial experts explained when and how to look into debt consolidation or settlement, as well as a few other ways to get out from under overwhelming bills or debt.
Debt Consolidation
Debt consolidation just refers to combining debts “under one umbrella,” at a favorable interest rate, according to Kyle Enright, president at Achieve Lending. The goal with this method is to pay off debts with higher interest rates so you’re left with just one loan at a relatively lower rate.
There are many ways to secure the funds to do this, each with its pros and cons. He laid them out:
Debt consolidation loan: “This is just a personal loan used for the purpose of consolidating and paying off high-interest debt,” Enright said. You do typically need a good credit score to qualify, however, often in the mid-600s. Your credit history and debt-to-income ratio will also be considered.
Balance transfer: This is when you transfer a high-interest credit card to one with a zero or very low interest rate. Note that you will want to “be able to pay off the transferred balance before the end of the promotional rate, which could be anywhere from six to about 21 months,” Enright warned. You’ll need good to excellent credit.
Home equity: Homeowners with substantial equity in their homes and with very good credit may qualify for a home equity line of credit or home equity loan and then use the funds to consolidate and pay off debt.
Retirement account: You may be able to borrow from a 401(k) or other retirement account and use the money to consolidate and pay off debt, but it’s usually not a good idea, Enright warned.
Life insurance: It’s also possible to borrow from a life insurance policy, but any amount withdrawn is money that will not go to beneficiaries.
Vehicle loan: You may be able to take out a loan on a vehicle with a clear title. Terms can be complicated and interest high, and if you miss any payments, you risk losing the vehicle.
Friends or family members: You may be able to borrow and use the funds to pay off other debts. While you may find a better interest rate than a bank would offer, there is also the possibility for strained relationships, and if you have trouble repaying, even legal action against you.
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When Debt Consolidation Is Right for You
Debt consolidation may be right for you under a variety of circumstances, according to Melanie Musson, a personal finance expert with Clearsurance.com.
- Good credit but too much debt: If a person holds a lot of debt but they have a good credit score and a good debt-to-income ratio, debt consolidation can help them to eliminate their debts more quickly and with a lower interest rate.
- Multiple debt sources: Debt consolidation can make sense when you feel overwhelmed by multiple sources of high-interest debt and are struggling to keep track of payment dates and balances.
- High-interest debt: Debt consolidation can also be a good idea if your sources of debt are primarily the high-interest type.
- Quicker balance pay down: Consolidation can help you save money over time if you can pay off the balances more quickly with the consolidation plan than if you had paid off your debts individually.
When Debt Consolidation Is Not Right for You
Debt consolidation is not for everyone, however. It’s usually not the best solution for people who are struggling to make minimum payments on current debt, Enright warned — particularly if they are in that situation because of a true financial hardship, such as loss of a job or loved one, a divorce or high medical bills.
In that case, debt settlement may be a better option than trying to take on additional debt — though that will have an immediate impact on your credit score.
If you’re looking to pay off high-interest debt, and you can obtain lower-interest debt to do so, it can make sense. “You just need to make sure your budget can comfortably accommodate the payments, and that you don’t rack up new debt on either the old or new loans,” Enright said.
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