See if debt consolidation is the right solution for challenges with credit cards, student loans or back taxes.
What is debt consolidation?
Debt consolidation doesn’t just refer to one solution. It encompasses a range of solutions that you can use to address challenges with credit cards, medical bills, back taxes and student loans. On a basic level, consolidation is a financial process that allows you to combine multiple debts into a single monthly bill. This simplifies your repayment schedule, as well as providing a range of other benefits.
As a general rule, you only consolidate debt with other similar types of debt. So, while there are solutions that consolidate student loans and solutions for credit cards, you usually keep them separate. This means if you hold several types of debt, you may need multiple consolidation plans to pay them off.
Benefits of debt consolidation
The primary benefit that spans all solutions for consolidating debt is a simplified repayment schedule. You only need to worry about one consolidated bill, rather than covering multiple payments throughout the month.
Outside of that benefit, most options offer other benefits, too. Consolidating debt may provide all or some of the following:
- Reduce or eliminate interest charges
- Lower your monthly payments
- Accelerate repayment so you can get out of debt faster
- Eliminate penalties or delinquencies
Types of debt consolidation
Here’s an easy snapshot the types of debt solutions available to consolidate each type of debt
|Credit consolidation||Student loan consolidation||Tax debt consolidation|
|Credit card balance transfer||Federal Direct Consolidation Loan||IRS Installment Agreement (IA)|
|Personal debt consolidation loan||Federal repayment plans|
|Home equity loan||Private consolidation loan|
|Debt management program|
You can learn more about each consolidation option and the benefits it offers by referring to the type of debt that you have below.
Credit consolidation allows you to consolidate debts from your credit cards; it can also apply to other unsecured debts, such as unpaid medical bills and payday loans. The primary benefit of consolidating credit card debt is that it minimizes interest charges. This typically allows you to get out of debt faster, even though you may pay less each month.
There are four basic ways to consolidate unsecured debt. This table explains the benefits of each option:
|Interest rate||Term (time to payoff)||Monthly payments||Warnings|
|Credit card balance transfer||0% APR for introductory period||Goal = total payoff at 0% APR; 6-18 months||Often higher than what you pay now||Only works for credit cards; only applies to credit cards|
|Personal debt consolidation loan||Usually between 5-10%||Recommended 36-72 payments||Often lower than what you pay now||Must have good credit to get the lowest rate possible; works for medical bills and other unsecured debts|
|Home equity loan||Usually between 4-7%||Typically, 5-15 years||Usually lower than what you pay now||If you default, the lender can foreclose on your home|
|Debt management program||Typically, between 0-11%||Most plans run 36-60 payments||On average, reduces up to 30-50%||You must enroll through a credit counseling agency; you can only include debts if the creditor agrees|
Consolidating debts with a balance transfer
This type of consolidation works best for limited amounts of debt. You consolidate by moving existing high-rate balances to a new account with 0% APR on transfers for a limited time. There’s usually a fee that ranges from $3 to 3% of each balance transferred. The length of the 0% APR promotional period varies, based on your credit score; most cards offer periods from 6 months to 18 months. This allows you to pay off your debt interest-free for a period of time, drastically improving your time to payoff.
This type of consolidation really only works for credit card debts. You can use the card to pay off other types of debt, but interest charges may apply. Only use this to consolidate an amount of debt that you can afford to pay off in the introductory period. Otherwise, high interest charges will apply again.
Paying off credit cards with a personal loan
This is another form of do-it-yourself consolidation. You take out a personal loan for an amount that covers all the debt you wish to eliminate. You qualify and get an interest rates based on your credit score; with excellent credit, you can usually get a rate around 5%.
You choose a term that offers monthly payments that you can afford. A longer term means lower monthly payments, but it increases the total cost of getting out of debt. By contrast, a shorter term helps minimize interest charges, but generates a higher monthly payment. Most experts recommend keeping the loan term to less than 72 payments – that’s six years to reach zero.
Once you qualify, you use the funds to pay off your credit card balances. This leaves only the low interest rate fixed loan payments to make.
Using your home’s equity to consolidate debt
This option is similar to a personal consolidation loan, except the loan is secured using your home as collateral. If you own your home and live in it as a primary residence, you can borrow against its equity. Equity is the value of your home minus the remaining balanced owed on your mortgage. Home equity generally increases as you pay off your mortgage and the home’s values naturally increases.
You can usually only borrow up to a certain percentage of equity – most loans cap out at 85% of the home’s value. You generally also have to pay closing costs, which come out to 2-5% of the loan amount. Once you receive the funds, you use the money to pay off your credit cards.
It’s worth noting that many experts recommend against using a home equity loan solely for the purpose of paying off credit cards. That’s because it converts unsecured debt into secured debt that uses your home as collateral. That means if you default, you can face foreclosure actions. This usually isn’t worth the increased risk just to pay off credit cards. That being said, if you take out a home equity loan for other purposes and use some fund to pay off credit cards, it may be a smart move.
Note that there is a variation of this solution called a Home Equity Line of Credit (HELOC). It’s like the loan, except you don’t receive the funds as a single lump sum. Instead you receive approval of a certain credit line that you can borrow against as needed.
Assisted consolidation through a debt management program
If you can’t qualify to consolidate credit card debt yourself and effectively pay it off, then need professional help. With this solution, you go through nonprofit consumer credit counseling to set up a repayment plan that fits your budget. Then the credit counseling team works with your creditors to get them to agree to the new payment schedule. They also negotiate to reduce or eliminate interest charges on your accounts.
Once your creditors sign off, your program starts. You make one payment to the credit counseling agency and they distribute the funds amongst your creditors as agreed. You pay back everything you owe, just with lower interest charges. This allows you to get out of debt faster, even though most program participants pay up to 30-50% less in total each month.
This is the only option for credit consolidation that you can use with bad credit. There’s also usually not a maximum limit to how much debt you can include in the program; there is, however, usually a minimum of $5,000-$10,000, depending on the agency. So, if you have $50,000 or even over $100,000 of credit card debt to consolidate, this can work.
Student loan consolidation
Unlike consolidating credit cards, student loan consolidation usually has little to do with the interest rates applied to your debt. That’s because student loan interest rates are rarely based on your credit score. Federal student loan rates are set according to the 10-year Treasury Note index; in other words, the government sets them each June for the next academic school year. Even private companies usually offer student loans at better rates than other loans they offer.
This is good when you apply for student loans, because you can get good rates even with bad credit or no credit. However, that means when you consolidate the debt, it typically doesn’t provide any interest rate reduction.
Instead, you consolidate to simplify your loan repayment schedule and do one of two things:
- Lower your monthly payments so it’s easier to meet the payments on a limited budget.
- Set a faster repayment schedule so you can get out of debt as quickly as possible
|Interest rate||Term (time to payoff)||Monthly payments||Warnings|
|Federal Direct Consolidation Loan||Weighted average of previous rates||10 years (120 payments)||Varies based on total education loan indebtedness||Must have at least one Direct or FFEL loan to qualify; doesn’t apply to private loans|
|Federal repayment plans||Weighted average rates on loans included||10-30 years (depends on program)||Higher if you go for fast repayment; lower if you choose an income-driven plan||Doesn’t apply to private loans; not all federal loans qualify unless you use Direct consolidation first|
|Private consolidation loan||Varies based on lender and loan chosen (fixed and variable available)||Set based on monthly payments you can afford||You set payments that work for your budget||This converts federal loans to private debt, making you ineligible for federal relief and loan forgiveness programs|
Using Federal Direct consolidation loan
This is a new loan that you take out through the Federal Direct loan servicing program. In order to use this loan, you must have at least one Direct or FFEL loan that you wish to consolidate. If you have at least one, then you can consolidate any of the following types of federal loans:
- Direct loans (subsidized / unsubsidized)
- FFEL program loans (subsidized / unsubsidized)
- Stafford loans (subsidized / unsubsidized)
- PLUS loans from the Direct program, not including loans to parents
- Perkins loans
- Supplemental Loans for Students (SLS)
- Federal nursing loans
- Health education assistance loans
- Other Federal Direct consolidation loans
Really, the only types of student loans that you can’t include are PLUS loans to parents, and private student loans. If you have private loans, you can’t use any federal program to consolidate them.
The rate on the new loan takes a weighted average of the rates on your original loans. As a result, this rarely provides any interest rate savings. Instead, it simplifies your repayment schedule and ensures all your federal student loans qualify for inclusion in a federal repayment plan (see more below).
Federal repayment plans
These are federal programs that aim to provide a better way to pay off student loans. “Better” depends on your situation – you either aim for lower payments or faster repayment to minimize total cost. There are seven different programs that you can use, based on your goals.
In some cases, you can simply enroll in a repayment plan directly. This is usually true if you have a straight forward assortment of loans, for instance, all Direct loans. However, not all types of student loans from the list above can be included. So, you often use this solution in combination with a consolidation loan. First you consolidate all your loans so that your total debt falls under the Direct loan program. Then you can include the consolidated debt into a repayment plan, regardless of where it originated.
Private consolidation loan
This is like a credit card debt consolidation loan, only for student debt. You take out a personal loan specifically for the purpose of consolidating student loan debt. Then you use the funds to pay off your existing loans. You can use this for private student loans and federal, making it the only solution that works for both. However, do this with caution, since it effectively converts your federal debt into private debt; that means you can no longer qualify for federal repayment plans or Public Service Loan Forgiveness.
As far as the loan goes, the interest rate for student loan consolidation if often lower than what you qualify for on other loans. Again, lenders tend to offer borrowing incentives to students which usually means lower rates. However, they typically won’t go much lower than they would for a loan origination. As a result, you may not be able to push your rate much lower than it already is. However, in some cases, there can be a rate benefit.
Tax debt consolidation
There is only one option that allows you to consolidate tax debt and it’s known as an IRS Installment Agreement (IA). An IA combines multiple years of unpaid tax debt into a single consolidated repayment plan. The monthly payments are set based on your income and financial situation; you work out a payment with the IRS that you can afford. You want to pay as much as possible, because penalties and interest charges continue to apply until you hit zero. Penalty interest can go up to 25% of the total amount owed, based on the penalties that the IRS assesses for you.
If you owe less than $10,000 in back taxes and don’t need any special considerations, you can enroll yourself. If you have more debt or a complicated financial situation, you’re usually better off going through a tax debt resolution service.
Debt consolidation FAQ
Can I reconsolidate?
In most cases, reconsolidation is possible. The only time it isn’t easy is when you’re talking about tax debt or because you secured a debt using collateral.
- For credit card debt:
- If you don’t eliminate a transfer by the end of the intro period, you can use any other option.
- You can also include a personal consolidation loan in a debt management program.
- You can drop out of a debt management program if you decide it’s better to apply for a loan.
- The only time you can’t reconsolidate is when you use a home equity loan; the debt is secured, so unsecured consolidation options don’t apply.
- For student loans:
- People often use a Federal Direct consolidation loan and federal repayment plan in combination; this allows you to make as many debts as possible eligible for federal repayment plan benefits.
- You can also include a Federal Direct consolidation loan with a new consolidation loan, as long as you have at least one new federal Direct loan.
- If you use a private consolidation loan for federal student loan debt, it is no longer eligible for any federal relief programs, including loan forgiveness.
- However, you can reconsolidate a private loan with a new consolidation loan from a private company
- For tax debt: If you default on an IRS Installment Agreement, you must explain the reason for default in order to reinstate your plan. The IRS also allows you to add new tax years to a current IA, which you must do to avoid default. The IRS frowns on dropping out of one IA and starting a new one fresh. Always do everything within your power to keep up with IA payments once the agreement is set.
How does debt consolidation affect your credit?
In most cases, consolidating debt should be good for your credit.
- It makes it easier to keep up with your payments so you maintain a clean credit history.
- Consolidation improves your credit utilization ratio by decreasing the amount of debt you owe
Of course, that only holds true if you stick to the payments and your elimination plan. If you miss payments by more than 30 days, it negatively impacts your credit. It can also decrease your score if you run balances back up on your credit cards after credit consolidation. If you close your accounts after you pay off the debt, it can decrease your score, too.
However, if you follow any instructions that you receive carefully and complete your program as schedule, you should have better credit at the end of your journey. Always take the step of checking your credit report after you consolidate. Make sure your report shows that you’ve paid everything off and that all your accounts are in good standing.
How do I compare options for consolidation?
You can compare debt consolidation options for each type of debt by measuring:
- Total cost (fees, interest charges and principal)
- Time to pay off (i.e. how long with this take?)
- Do the monthly payments work for your budget?
You want to choose the plan that works for your budget while getting you out of debt as quickly as possible. Always compare solutions using these three metrics before you sign up for one. However, avoid choosing the option with the lowest payments because it seems easiest; low payments usually mean higher total costs.
Why can’t I consolidate credit cards and student loans?
This is one of the most common questions with debt consolidation. Since you can use a debt consolidation loan through a private lender for both credit cards and student loans, why can’t you do both at the same time? Two financial birds with one consolidated stone.
The answer is, that it’s complicated. Remember, student loan interest rates don’t work like other types of financing. So, most lenders won’t let you use funds from a debt consolidation loan with a sweet student loan rate to pay off credit cards. They kind of consider it an attempt to game the system.
It also gets complicated if you ever declare bankruptcy. Student loans – both private and federal – can’t be easily discharged through bankruptcy. Credit card debt can and usually is eligible for discharge. However, what happens when you combine the two types of debt together? In this case, the student loan discharge roadblock would apply.
That’s why most lenders won’t let you consolidate both types of debt together. And if you can find a lender that will let you, it doesn’t mean that you should. Again, if you ever head to bankruptcy court, it could be a nightmare. You’re better off to run two consolidation plans at once – one for each type of debt.
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