Best Way to Consolidate Debt

Highlights

  • Facts, figures, and hard data about debt consolidation choices.
  • Credit counseling is great if you want to preserve a high credit score.
  • Pick debt settlement if you want a fast, low-cost way to fix your debt problem.
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Learn the 5 Best Ways to Consolidate Debt, and How to Pick the Right Way For You.

People often ask Bills.com “What is the best way to consolidate debt?” Many consumers wrestle with the competing debt consolidation choices, all of which claim to be right. Which is the best? If your debt causes you distress, read on!

This article looks at five ways to consolidate debt and helps you decide which is right for you. Let’s look at your choices:

  • Consumer Credit Counseling
  • Debt Settlement
  • Home Loan Refinance
  • Chapter 7 Bankruptcy
  • Chapter 13 Bankruptcy

Before we discuss each of these options, understand these four truths about debt consolidation:

  • No one-size-fits all debt consolidation solution exists
  • Different people and households have different goals and needs
  • If overspending and lack of budgeting is the source of your money problems, debt consolidation is just a Band-Aid on an unresolved problem
  • Every debt consolidation plan comes with benefits, costs, strengths, and weaknesses

This article looks at the numbers behind each of the best debt consolidation solutions. We base these numbers on the well-researched Bills.com White Paper on Debt Solutions. This article summarizes the findings in that 10-part report. If you want to dig deeper into the numbers shared here, follow the hyperlink just mentioned. A table below contains all of the facts and figures we are about to discuss.

Let's start with consumer credit counseling.

Consumer Credit Counseling & Debt Management Plan

Consumer credit counseling contains two parts — counseling and a debt management plan (DMP). The counseling component is key for people who overspent, are living beyond their means, and will benefit from setting up a monthly budget. Counseling dives into the root causes of the debt, and helps people develop livable budgets, so consolidating debt does not become a recurring event.

The other half of consumer credit counseling is the DMP. A DMP is a 5-year plan where the credit counselor approaches the consumer's creditors and convinces them to accept a lower interest rate in exchange for 100% repayment. The big advantage of a DMP is the light impact it has on a consumer's credit score. The downsides include the high monthly payments.

Debt Settlement

Debt settlement is similar to consumer credit counseling in that the better companies offering this service help people understand the causes of the debt, and develop a budget that can help them live comfortably with savings. Debt settlement has important differences, though. People in debt settlement programs stop paying enrolled debt. Instead, they deposit funds into a special account. When the account contains enough money, the debt settlement negotiators step in and negotiate lump-sum settlements with creditors.

The upsides of debt settlement include the shortness of the program in comparison to consumer credit counseling and chapter 13 bankruptcy. The costs are cheaper than credit counseling. However, the downsides are bigger, too. They include damage to the person's credit score, and the possibility of being sued by a creditor. This is definitely a "no-pain, no-gain" type of debt consolidation solution where the upsides are very high, but at the cost of some risk.

Home Loan Refinance

Let us cut right to the important part of a cash-out refinance as a way to consolidate debt. If you have these two important items, a home loan refinance is a viable solution for you to consider:

  1. You own property with a substantial amount of equity, and
  2. You have a high credit score

Do you have both? If yes, review the information in the Bills.com article about home loan refinancing, so you better understand its pros and cons. If you own a home but have a low credit score, then you will not qualify for a cash-out refinance.

Bankruptcy

There are many types, called "chapters," of bankruptcy. Consumers who qualify file for chapter 7 or chapter 13 bankruptcy. In a chapter 7 bankruptcy, all qualifying debts are discharged (canceled) by a federal court's declaration. A chapter 13 is similar to consumer credit counseling, except the court works with the consumer to determine what payments he or she can afford every month. Then, at the end of 5 years, the remaining debt is usually, but not always, discharged by the court.

The advantage of chapter 7 bankruptcy is speed to debt freedom. A major disadvantage is the harm caused to a credit score. The advantage to chapter 13 is that if a consumer has a particularly aggressive creditor, federal law forces the creditor to accept the court's payment plan. The disadvantages to chapter 13 are the same as chapter 7 — harm to credit score.

Debt Consolidation Solutions at a Glance

If the table below seems a little overwhelming at first, stop and go back up the page to review the discussion of each way to consolidate debt. Remember; each solution has strengths and weaknesses. The trick to finding the best way to consolidate debt is to rank your needs. We share a handy debt consolidation checklist below this table.

One important note about this table: The cost comparisons below start with the assumption that a person has $20,000 in credit card debt. All assumptions about interest rates and fees were reasonable and average at the time the Bills.com whitepaper was written in 2010.

  Consumer Credit Counseling Debt Settlement Home Loan Refinance Chapter 7 Bankruptcy Chapter 13 Bankruptcy
Pros, cons, and costs of debt consolidation strategies
Monthly payment $400 - $600 $300 - $400 $100 - $200 None Varies
Program length (months) 60 36 - 48 480 - 360 6 - 12 60
Typical Total Cost $30,000 $13,000 $40,000 $1,500 $14,000
High credit score necessary? No No Yes No No
Credit score impact Minimal score impact, but will be noted on credit report Significant score impact if consumer has a high score at present None Significant Significant
Positive Repays entire balance due Lowest-cost, fastest program that avoids bankruptcy Lowest monthly cost for resolving debt If you qualify, the fastest way to achieve debt freedom Repays some debt. Forces creditors to accept less than full balance
Negative High monthly payments. 21%-26% completion rate Possibility of creditor litigation. Collection calls Must own home with equity. High lifetime cost Credit score impact. Not all debts qualify for discharge Credit score impact, length of plan, remaining debt may not be discharged
Notes Assumes 11.9% interest rate and $50 monthly account fees Assumes 50% settlement rate and 21% of debt total fees. Results in these programs may vary dramatically Adds to debt load of property Must qualify for means test, and not all debtors qualify Stay shields debtor from creditor calls. Many debts are discharged after 5 years

Here is one way to rank your debt consolidation choices:

Credit score

I have a high credit score and must preserve my credit score at all costs: Look at credit counseling closely.

No Available Cash Flow

I have no monthly cash-flow at all to put towards paying-off my debt: Look at bankruptcy.

Speed

I do not want to file bankruptcy, or do not qualify for chapter 7, and want to achieve debt freedom at low cost: Debt settlement might be right for you.

I Have Equity

I own and have equity in a home. I have a high credit score: Consider a refinance.

Summary

As mentioned at the start of this article, there are no perfect ways to consolidate debt. Everyone has different needs. Fortunately, there are five debt consolidation solutions for you to choose from.

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