Debt Consolidation for Every Type of Debt

If you’re looking to start your year with the right plan to get out of debt, you’ve come to the right place for your concerns about debt. Whether you are struggling to pay off credit card debt, medical debt, student loans or even back taxes, debt consolidation may be a solution. It’s a form of debt relief that rolls debts into one monthly payment.

Because consolidating your debt reduces or eliminates interest charges it becomes easier to get out of debt. This lets you focus your efforts on paying back the principal without worrying about throwing away money on interest charges. Stick around as we guide you through the various options to consolidate debt.

Table of Contents:

What is debt consolidation?

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.

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 use debt consolidation when you have multiple debts of a similar type to repay.
• Then you find a solution that combines them into one repayment plan.
• It simplifies your bill payment schedule with just one bill.
• You pay back everything you owe more efficiently.
• At the same time, you may reduce or eliminate interest charges applied to the debt, although this doesn’t occur in all cases.
• Consolidation can also stop future penalties if you’ve fallen behind on any debt payments.
• You minimize or completely avoid credit damage that can be caused during debt repayment.
• 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.

How to consolidate debt

There are two different ways to consolidate debt. The best way to consolidate debt depends on your unique financial situation.

1. New financing: Apply for new financing and use the new credit line to pay off your existing debts. This is a DIY solution that works if you have good credit.
2. Debt consolidation program: Arrange a repayment plan that pays off your existing debts, but you still owe the original creditors. This option may be better if your credit score is not the best.

How to consolidate debt 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 a Home Equity Loan. Here are the steps involved.

1. You apply for a loan or credit line that’s large enough to pay off all the debts you wish to repay.
2. You get approved based on your credit score; approval requirements vary by lender and the type of consolidation loan that you want.
3. You choose a term for the loan that offers monthly payments you can afford.
   1. A shorter-term means higher monthly payments, but lower total costs
   2. A longer-term decreases the monthly payments but increases total costs
4. Once approved, you use the funds you receive to pay off your existing debts.
5. 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.

1. First, determine what monthly payment you can afford on your budget.
2. Then, structure a repayment plan that uses that monthly payment amount to repay all debts included in the plan.
3. Interest charges still apply during repayment, but they may be reduced or eliminated; setting up a repayment plan generally stops penalties from being applied.
4. 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

With credit card debt, the goal of consolidation is always to reduce or eliminate interest charges applied to the debt. Credit cards have relatively high interest rates, which makes it difficult to pay off balances quickly. Consolidations roll all those balances into one repayment plan at the lowest interest rate possible.

There are four ways to consolidate credit card debt, and only three of them are generally advisable.

1. Credit card balance transfers only work if you have a limited about of debt and a good credit score.
2. A personal debt consolidation loan is another form of do-it-yourself debt consolidation. It generally only works if you have a good credit score.
3. A debt consolidation program is the only solution you can use to consolidate debt if you have a bad credit score. It’s also referred to as a debt management plan or debt management program. It’s important to note that this solution doesn’t transfer your debt to the credit counseling agency. You still owe your original creditors. This is basically a professionally assisted repayment plan that makes it faster and easier to get out of debt.
4. Home equity loan / HELOC / cash-out refinance might allow you to borrow against the equity in your home. This is not recommended because you have traded an unsecured loan for a secured loan.

Consolidating student loan debt

Student debt is a little unique when it comes to consolidation. Interest rate reduction is not always the primary goal. That’s because federal student loan interest rates work differently than rates on other types of debt. As a result, you can’t always consolidate to cut interest rates.

Instead, you generally consolidate student loans to achieve one of two things:

• Faster loan repayment
• Lower monthly payments

That being said, there is a way to lower APR on student loans. However, it converts any federal student loan debt to private, which makes you ineligible for programs, like student loan forgiveness.

There are only two ways to consolidate student loan debt:

1. A federal debt consolidation loan can only use this solution to consolidate federal student loans; this does not include PLUS loans to parents or private student loan debt.
2. 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

If you owe back taxes to the IRS, you can consolidate the debt from multiple filing years into a single repayment plan.

There are two basic ways to consolidate tax debt:

1. Set up an Installment Agreement (IA) with the IRS
2. 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 for 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.

Debt consolidation questions

contributor

Howard DvorkinAuthor

CPA - Debt.com Chairman & Personal Finance Expert