What is debt consolidation?
If you’re making debt payments every month, but it feels like you’re getting nowhere fast, it may be time to consolidate your debt. You may have heard the term “consolidation” but unless you’ve used one of these solutions before, you may not understand exactly how it works.
The goal is to pay back everything you owe more efficiently.Debt consolidation refers to any debt relief option that rolls debts of the same type into a single monthly payment. The goal of consolidation is to pay back everything you owe more efficiently. This helps minimize damage to your credit score, which often makes this a more desirable solution versus debt settlement.
So, how do you do it right? Debt.com will show you how to consolidate your debt by yourself, or how to consult a professional who can walk you through it. Even if you go your own way, it doesn’t hurt to consult a certified credit counselor for free debt analysis.
You can also learn about other options like a debt management program or debt settlement. But first, find out if debt consolidation is right for you.
Consolidating debt focuses your money on paying off the principal.In most cases, consolidating debt allows you to reduce or eliminate interest charges. As a result, you can get out of debt faster because you focus your money on paying principal, or on the actual debt you owe.
Benefits of debt consolidation
- You pay back everything you owe more efficiently.
- You minimize or completely avoid credit damage that can be caused during debt repayment.
- It simplifies your bill payment schedule with just one bill.
- With most consolidation solutions, you also reduce or eliminate interest charges.
- This can make debt repayment faster, even though you may pay less each month.
Types of Debt You Can Consolidate
In general, you can only consolidate similar types of debt. While you can consolidate credit cards and student loans, you usually have to keep them separate. If you owe multiple types of debt, you may need more than one debt consolidation plan.
|Types of Debt Consolidation||Debts that can be included|
|Unsecured debt consolidation (commonly called “credit card debt consolidation” or “credit consolidation”|
|Federal student loan debt consolidation||Most federal student loans, not including PLUS loans to parents|
|Private student loan debt consolidation|
|Installment agreement (IA)||IRS tax debt from multiple years of back taxes on income tax returns|
|Auto loan consolidation||Auto loans on different vehicles|
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How Does Consolidating Your Debt Work
There Are 2 Ways To Consolidate…
There are two different ways to consolidate debt. The best way to consolidate debt depends on your unique financial situation.
- New financing: Apply for new financing and use the new credit line to pay off your existing debts.
- Debt consolidation program: Arrange a repayment plan that pays off your existing debts, but you still owe the original creditors.
How It Works With New Financing
The most common form of consolidation that uses new financing is a debt consolidation loan. However, there are also other versions, such as a Home Equity Line of Credit (HELOC) or balance transfer credit card. Here are the steps involved.
- You apply for a loan or credit line that’s large enough to pay off all the debts you wish to repay.
- You get approved based on your credit score; approval requirements vary by lender and the type of consolidation loan that you want.
- You choose a term for the loan that offers monthly payments you can afford.
- A shorter-term means higher monthly payments, but lower total costs
- A longer-term decreases the monthly payments but increases total costs
- Once approved, you use the funds you receive to pay off your existing debts.
- This leaves only the consolidation loan to repay.
How Does Using a Consolidation Program Work
This type of debt consolidation does not replace old debt with new financing. Instead, you still owe the original creditor. It’s a structured debt repayment plan.
- First, determine what monthly payment you can afford on your budget.
- Then, structure a repayment plan that uses that monthly payment amount to repay all debts included in the plan.
- Interest charges still apply during repayment, but they may be reduced or eliminated; setting up a repayment plan generally stops penalties from being applied.
- You make fixed payments according to the agreed schedule until your debt is paid off.
Again, the specifics tend to vary based on what type of debt you owe. Consolidation programs are most commonly seen with tax debt and credit cards.
Consolidating Credit Card Debt
There are four ways to consolidate credit card debt, and only three of them are generally advisable.
- Credit card balance transfer
- A personal debt consolidation loan
- Home equity loan / HELOC / cash-out refinance
- Debt consolidation program
Looking for the best way to consolidate credit card debt? Let Debt.com connect you with a top-rated certified consumer credit counseling service to get the answers you need.
Consolidating Student Loan Debt
There are only two ways to consolidate student loan debt:
- A federal debt consolidation loan can only be used to consolidate federal student loan debt.
- On the other hand, private debt consolidation loans can be used to consolidate both private student loan debt and federal student loan debt.
Consolidating Tax Debt
There are two basic ways to consolidate tax debt:
- Set up an Installment Agreement (IA) with the IRS
- Include it in a personal debt consolidation loan
Specialized Types of Debt Consolidation
Consolidating Payday Loans
It is possible to consolidate payday loans, but it’s usually limited to using a debt consolidation program.
Consolidating Military Debt
Military Service Members and Veterans have a special option for debt consolidation called a Military Debt Consolidation Loan (MDCL). They also usually qualify for discounted fees when they enroll in a debt consolidation program.
Using a Military Debt Consolidation Loan (MDCL)
If you purchased your home using a VA home loan, you are eligible to get an MDCL. It’s a loan that borrows against the equity in your home. The MDCL is a cash-out refinance mortgage that pays off your original loan and then gives you the cash difference in equity. So, if your home is worth $120,000 and you owe $80,000 on your original VA home loan, the MDCL gives you a loan for $120,000. You get the $40,000 difference back and can use the funds to pay off debt.
The issue here is still that you borrow against your home’s equity, so you take on an increased risk of foreclosure with an MDCL. In many cases, you are better off using a debt consolidation program, particularly given that military Service Members and Veterans qualify discounted fees on debt management programs.
Consolidating Medical Debt
It’s also possible to consolidate unpaid medical bills using a debt consolidation loan or debt consolidation program. If you had out-of-pocket medical expenses that were not paid by insurance, these bills can quickly turn into collections. Medical debt collections are the number one cause of bankruptcy in the U.S.Back to top
Debt Consolidation Questions
Q:Can you consolidate other types of debt?
Q:Does debt consolidation affect your credit?
Q:Does debt consolidation work?
Q:Is debt consolidation a good idea?
Q:Is debt consolidation worth it?
Q:When should I consolidate my debt?
- Individual debt payments are taking up too much income and you want to lower your monthly payments through debt consolidation.
- You want to reduce the total cost of repaying your debt by reducing applied interest charges.
In many cases, with both debt consolidation loans and consolidation programs, your total monthly payments are reduced. With reduced or eliminated interest charges, you can get out of debt even though you often pay significantly less each month.
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Article last modified on April 10, 2020. Published by Debt.com, LLC