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Debt Consolidation: A Good Idea?

Updated: Oct 20, 2014

Highlights

  • Pick the debt consolidation strategy that fits your needs.
  • Debt settlement is a good idea if you want to be debt free quickly at low cost.
  • Credit counseling preserves your credit score, but comes at a high monthly cost.
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Learn Positives & Negatives About 5 Different Debt Consolidation Strategies

“Debt consolidation” is a general term, used widely by different people to mean different strategies for resolving debt. Deciding if debt consolidation is a good idea depends on the strategy, and just as importantly, if it meets the needs of the consumer.

When it comes to debt consolidation, there is no perfect strategy that fits every person’s needs exactly. What works best for you may be terrible for your neighbor. Beware people who say in online forums, “Don’t do {debt consolidation strategy X}. It’s terrible!” because they may not understand all of the positives and negatives for every strategy, and may not understand what works for them may not be a smart choice for someone else.

Quick tip #1

Receive a no-cost, no-hassle debt relief quote from one of Bills.com’s pre-screened debt providers.

This article explains the situations where each debt consolidation strategy is a good idea, and where it is a bad idea. It includes relative cost information, and hyperlinks to Bills.com resources to learn more about each. Here are the five common debt consolidation strategies we will discuss:

  • Personal Loan
  • Home Loan Refinance
  • Debt Settlement
  • Consumer Credit Counseling & Debt Management Plan
  • Bankruptcy

Personal Loan

Personal Loan
Good Idea Bad Idea
Loan can be for any reason • Requires high credit score
• High interest rate: 15% - 20%

A personal loan is not secured, or tied to a specific item such as a vehicle or house. These are also called "signature loans" because all you need to get this type of loan is your signature on the contract. You can find personal/signature loans at banks, credit unions, and now peer-to-peer lenders including Prosper and Lending Club.

Debt Settlement

Debt Settlement
Good Idea Bad Idea
• 36 - 48- month program length
• Low monthly payment
• Lowers credit score
• May result in litigation

Debt settlement is an alternative to consumer credit counseling and bankruptcy. Like credit counseling, a person in a debt settlement plan enrolls their debts in the program. The person then stops making payments on the enrolled debt. Instead, the person deposits funds into a special account that is in their name. The more a person pays into the special account each month the faster the person completes the program. As the account grows, the debt settlement company negotiates with creditors. In the negotiations, the debt settlement company and the creditors agree to a lump-sum settlement for a fraction of the amount due.

Consumer Credit Counseling & Debt Management Plan

Consumer Credit Counseling
Good Idea Bad Idea
• Repays entire debt balance
• No credit score impact
• High monthly payment
• Long time to complete

In consumer credit counseling, the person enrolls their debts in something called a debt management plan (DMP). The credit counseling provider will negotiate lower interest rates with each creditor, and then sets up a monthly payment amount. Typical DMPs take five years to complete. Credit counselors typically spend an hour with the person working out a household budget to encourage savings instead of spending.

Home Loan Refinance

Home Loan Refinance
Good Idea Bad Idea
• Low monthly cost of repaying loan
• Can take advantage of today's low rates
• High lifetime loan cost
• Requires high credit score
• Burdens home with increased debt load

A cash-out refinance converts some of the equity you own in your home to cash. A cash-out refinance can be used to consolidate debt, make home improvements, buy more property, or pay for college, among thousands of other uses for cash. You need to own property to even consider a refinance. Also, you will need equity in the property, too. Therefore, this is a debt consolidation idea suited for homeowners who own their property outright, or who have more than 20% equity in their property.

Bankruptcy

Bankruptcy
Good Idea Bad Idea
• Fastest way to debt freedom – maybe
• Automatic "stay" holds creditors at bay
• Should be done with lawyer's aid
• Remains on credit report for 10 years

A discussion of bankruptcy can sometimes degenerate into legal techno-babble because the qualifications for bankruptcy are exact but contain exceptions and conditions. This may be one reason why some avoid bankruptcy. Don't let this deter you from learning more about bankruptcy, because it can be an effective tool if your debt distresses you.

Chapter 7 bankruptcy discharges qualified debts completely in a process that takes six months to a year to complete. Whether a person qualifies for chapter 7 depends on the amount of their debt and their level of income. A chapter 13 bankruptcy is the alternative to a chapter 7. Here, the court sets up a 5-year payment plan where the creditors receive a small amount of the balance due each month. Remaining debt is discharged at the end of the 5-year plan, typically.

Summary

Pick the debt consolidation strategy that is a good idea for your needs, and avoid listening to the naysayers who think their pet debt consolidation strategy is a good idea for everyone in every situation. As we discuss above, each debt consolidation strategy has strengths and weaknesses. Pick a debt consolidation plan that's the right idea for you.

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(6 Votes)