Ask Bill your personal finance question

Bad Credit Consolidation Loan

I have bad credit and I want to know if I can get a loan to consolidate all my credit problems.

I have bad credit and I want to know if I can get a loan to consolidate all my credit problems.  Also, I would like to pay a lower interest rate to cut my monthly payment.

Read full question
Bill's Answer
3.9
/5.0
(7 Votes)

Erase Debt With A Bad Credit Consolidation Loan
Highlights

  • If you have bad credit, a new loan may not be possible.
  • Consider a cash-out refinance if you have equity in your home.
  • Consumer credit counseling is one alternative to a bad-credit loan.
  • Another alternative that does not rely on your credit is debt settlement.

A bad-credit debt consolidation loan is one way to handle debts that distress you, but a consolidation loan is not your only choice. My answer discusses bad-credit debt consolidation loans and your non-loan options.

Cost of Common Loans

You do not include any facts in your question so allow me to invent some of my own to illustrate my points. Let us use average debt amounts for loans many people pay today.

According to the Federal Reserve, the average amount financed in a new vehicle loan is $26,673 for about 62.3 months at an interest rate of 4.73%. The average amount financed in a used car loan is $18,723 at 7.73% and a loan length averaging 64.5 months. According to Credit Karma, the average vehicle loan amount is $15,504.

According to Credit Karma, the average mortgage debt is $173,876, (average equity is $48,310). We will estimate the average interest rate is 6% on a 30-year fixed-rate loan.

For a person with an account, the average credit card loan balance is $6,576, according to Credit Karma, and the average interest rate is 14.97%, according to CreditCards.com.

Student loan debt is significant for people with student loans, but not everyone has a student loan. According to Credit Karma, the average consumer with a student loan has a balance of $26,272. Interest rates for recent federal loans vary from 5% to 7.9%, and have a term of 10 years.

Given these numbers, let's look at how the "average" US person's debt budget looks:

Loan Average Balance Average Rate Average Term (months) Monthly Payment Able to Consolidate?
Average US consumer loan amounts in 2011. Sources: Federal Reserve, Credit Karma, CreditCards.com, Bills.com
Home Loan $173,876 6% 360 $1,042.74 (1)  
Vehicle (new) $26,673 4.73% 62.3 $485.76 Yes
Vehicle (used) $18,723 7.73% 64.5 $353.46 Yes
Credit Card $6,576 14.97% revolving $148 (2) Yes
Student Loan $26,272 6.9% 120 $303.69 Yes (3)
Total/Average $252,120 8.07% 151.7 $2,333.65  
(1) Does not include taxes & insurance
(2) Interest plus 1% of balance
(3) Federal loans can be consolidated with other federal loans.

Loan Consolidation Options

You have three loan consolidation options:

  • A new loan
  • Refinancing an existing loan
  • Home equity loan

New Loan

A new loan to consolidate your debt would almost certainly be an unsecured loan. These loans are known in the banking world as signature loans. These are available for as little as $250 and up to $25,000 for terms as long as five years. Rates vary, but are relatively high — 16%.

Signature loans are available to people with high credit scores and typically have a long-standing relationship with the bank or credit union making the loan. Let us assume for a moment you have excellent credit. Is a signature loan a good deal? Let us look at the numbers and see.

A new-car loan has an interest rate of 4.73%, and a used-car loan costs 7.73% per month, so on an overall cost basis it does not make sense to trade-up to a 16% loan. Also, as we see, most car loans today have more than 60-month terms, so unless you are 30 months or so into a car loan, refinancing to a signature loan will not cut your monthly payment.

Refinancing a credit card or two to a signature loan may make sense if the credit cards have an interest rate exceeding 16%. However, if a lower monthly payment is your goal, keep in mind that a signature loan must be repaid in 60 months or less. So again, a signature loan may not make sense for credit cards.

A student loan's term is 10 years or longer, and typically has an interest rate around 7%. Therefore, the interest cost and monthly payment of a typical student loan is less than a similar amount in a 5-year 16% signature loan.

Refinancing

Consumers have three options to refinance:

  • Home loan
  • Vehicle loan
  • Student loan

Let us take a brief look at the terms, conditions, and costs of each.

Home Loan Refinance

Today, many people own homes that are worth less than their loan balances. However, that is not true for the vast majority of homeowners. If you own a home with equity then consider a cash-out refinance.

Refinance rates are attractive, and as of this writing are in the 4% range for borrowers with high credit scores. The advantage of a cash-out refinance is the interest paid may be deductible, and because the loan is paid over 20 or 30 years, the monthly out-of-pocket payment is low. Any loan can be consolidated by a cash-out refinance, including a vehicle loan, credit card debt, or student loan.

The disadvantages of a cash-out refinance are daunting. First, the total cost of the loan is high because you are stretching the payments over 20 or 30 years instead of 5 or 10 years. Second, burdening your home with additional debt can create a difficult situation in the future if you cannot afford a higher mortgage payment. Third, refinances are not free — expect to pay at least 1% of your loan balance in lender and third-party fees for a refinance. Finally you need a high credit score and home equity to qualify for a cash-out refinance.

Vehicle Loan Refinance

If a vehicle loan is causing you financial distress, then a refinance may be a great choice to cut your monthly payments and your lifetime cost of the loan. Some banks and credit unions are offering vehicle refinances to 1.99%. If, for example, you have an 8% vehicle loan with about $18,000 remaining on the loan, cutting the loan to about 2% will save you about $50 a month, or about $3,000 over the life of a 5-year loan. However, a vehicle loan refinance at low rates is only available to people with high credit scores.

A cash-out vehicle loan, called by some lenders an auto equity loan, is also offered by many banks and credit unions. Rates vary, but as of this writing in March 2012, Wells Fargo offers rates in the 4% to 5.5% range, depending on the region of the country and credit score of the applicant. Some banks charge a $200 loan application fee, and require the borrower be a homeowner or have other active accounts in that bank or credit union. The applicant's credit score is an important part of the approval process, so a low score may disqualify a potential borrower.

Student Loan Refinance

You are in luck if you want to refinance a federal student loan, as there are several programs available. See the Bills.com article Consolidate Student Loans to learn more about consolidating federal and private loans. The good news here is that a high credit score is not always necessary for a student loan refinance.

Home Equity Loan

A home equity loan is another form of mortgage. Before the term "home equity loan" was invented, people called these "second mortgages." The 2008 mortgage bubble burst took with it the home equity loan market. Few banks and credit unions offer these today in earnest. Those that do accept applications do so from people with very high amounts of equity in their property, and who have high credit scores. If you own a property outright, consider a home equity loan even if your credit score is not pristine.

Alternatives to a Bad-Credit Debt Consolidation Loan

It is pretty clear from the discussion above that a bad-credit debt consolidation loan may not be possible. Almost all new loans, and most refinances, require the borrower to have something other than a low credit score. Also, even if you have a high credit score, a consolidation loan may be an expensive means to handle debt. The good news is you have other options to resolve debt, and two we discuss below do not require a high credit score.

Credit Counseling

If your the debt causing you distress is from credit cards, consider Consumer Credit Counseling Service (CCCS). These companies help people with financial counseling, budget planning, and debt management plans (DMPs). In a DMP, the CCCS arranges a new payment amount with each of your creditors that is based on a lower interest rate. You then make a monthly payment to the CCCS, which distributes the funds to creditors.

Like everything in life, CCCS has positives and negatives. The positive is you repay 100% of your debt to your creditors. This results in a light impact on your credit score, although being in a DMP is mentioned on a consumer's credit report.

The negatives vary according to your goals. Depending on the creditors, the CCCS may not be able to reduce your monthly payments enough to reduce your financial distress. Second, being in a DMP will reduce your chances to obtain a loan while you are in the program, so you may not wish to enter a DMP if you anticipate any large purchases, such as home or an auto, soon. Third, the average DMP takes 5 years to complete.

Debt Settlement

Debt settlement is an alternative to CCCS, consolidation loans, and bankruptcy. Rather than making monthly payments to your creditors, debt settlement companies negotiate lump-sum settlements with creditors, often reducing debts substantially.

The positives of debt settlement are speed and cost. Debt settlement programs usually take 3 to 4 years to complete, and this varies based on the creditors, the amount of debt, and how much a consumer contributes to their plan each month.

The downsides are related to how debt settlement works. The consumer stops paying creditors, which has negative consequences. Your credit score will decrease while in the program, and you will be exposed to your creditor's collection efforts, including letters calls, and threats of lawsuits. However, if you are unable to afford to pay your creditors, the hit to your credit scores and the inconvenient calls are worth the benefit of ridding yourself of credit card debt in a short period of time.

Get Debt Help!
3.9
/5.0
(7 Votes)

2 Comments

Recent Best
1500 characters remaining
  • BA
    May, 2008
    Bill
    Having refinanced before is not the barrier you need to worry about. It is being behind on your payments, having less than good credit, and struggling with debt-to-income issues that make refinancing very difficult, if not impossible.
    0 Votes

  • DS
    May, 2008
    Denise
    Dear Mr. Bill, can i qualify for a home equity loan if i have already refinanced my home loan with a different loan company from the original loan company My credit is not good and i am 2 months behind in my mortgage payment. I am self employed and i am having a hard time keeping up with all my expenses.
    0 Votes

loading...