The Best Ways To Consolidate Debt

by Gerri Detweiler

What do you do when you find yourself with too much debt, or high interest rates? Consolidating bills isn’t always easy. If you have a lot of debt, it can be hard to find a consolidation loan at a lower interest rate. And if you’re not careful, you can end up deeper in debt than when you started.

Your goal in consolidating your debt should be to lower your overall costs. To accomplish this there are two things to keep in mind:

• Get the lowest interest rate possible.
• Have a plan to pay off your debts in 3 – 5 years.

Here are some of the best ways to consolidate:

Credit Cards

With many low rate offers out there, this can be one of the easiest ways to consolidate. Start by calling your current issuer to ask what interest rates they will offer you if you transfer balances from other cards over to theirs. Go for a fixed rate if you can get it, and ask them to waive any transfer fees.

Be careful! Too many applications in a short period of time can hurt your credit rating.

Betting the Farm

With a home equity loan, you borrow against the value of you home, minus any other mortgages. The two major kinds are: 1. A Home Equity Loan – a fixed amount of money for a fixed period of time (sometimes at a fixed rate) and 2. A “Home Equity Line of Credit” where you borrow up to a pre-approved credit limit (interest rates usually variable) and can borrow again if you still have money available.

These loans can offer attractive rates, and the interest is usually tax-deductible if you itemize. Many issuers offer no or low closing costs for these loans. Interest rates are often variable, however, and there’s always the risk that you can lose your home if you can’t pay.

Refinancing your home and taking out money to pay off bills (called “cash-out refinance”) is yet another way to tap the equity in your home. If you can refinance at a substantially lower interest rate, you’ll eliminate the high interest costs of the debts you pay off, and you could even come out with a lower payment than you already have since rates are so low.

Make sure you understand the total cost of refinancing. Take any money you’ve freed up by paying off other bills and use that to create an emergency savings fund.

Traditional Debt Consolidation Loans

A debt consolidation loan is an unsecured personal loan, and the only collateral you are offering for the lender’s security is you. Because lenders consider them risky loans, they’re usually more expensive and not always easy to get if you have a lot of debt.

If the interest rate is too high to make it worth it and the repayment term is ten or fifteen years, you should probably consider another method of consolidation. However, if the term and interest rate are right, this can be a great way to actually save money in the end. (Check Bankrate.com for current averages). Remember, to calculate the total cost of the loan from start to pay-off.

Getting Help

Credit counseling agencies may help you get out of debt, though they don’t actually consolidate your debt. Instead, payment plans (usually with lower interest and fees) will be worked out for all of your eligible debts. You’ll make one monthly payment to the counseling agency, which will pay all your creditors.

Participating in a credit counseling program generally won’t hurt your credit rating, and if you stick to the plan you can be out of debt in three to six years. But be careful which agency you work with. If the counseling agency pays your bills late, you’ll pay the price since you’re still responsible to the lender. It happens.

Another option is a debt negotiation company. You stop paying your bills and instead make a regular monthly payment to the company. Your creditors are instructed to contact them and not you about your overdue bills. As your accounts fall further behind, the negotiation company will settle your balances for 25 -- 50% of your balance, depending on the debt. Most people can be out of debt in less than two years or less using these programs.

It will hurt your credit rating in the short run, but over the long term you can build better credit because you’re essentially starting over without filing bankruptcy.

Retirement Loans

If you have a 401(k), 403(b) plan or certain types of pension plans, you can borrow against your nest egg. (You can’t borrow against your IRA.) It’s easy, with no income qualifications or credit check.

The key here is to borrow against your retirement account, rather than withdraw from it early so that you don’t end up paying taxes and a 10% penalty. Also, if you leave or lose your job, you may have to pay your loan back immediately or pay taxes and penalties for an early withdrawal.

These loans typically offer low interest rates, and interest is paid to you, since you are the lender! While tapping your next egg like this can short-change your retirement, so can costly debt payments. If you are in your 20’s and 30’s, you obviously have more time to rebuild a retirement nest egg, but even if you’re in your 40’s or 50’s, you will want to weigh the cost of paying the high interest of the debts over time, versus borrowing from your retirement account. The return you get from paying off high-rate debts is guaranteed – while the stock market isn’t.

Overview

Whatever method you choose for consolidating debt, the next step is to create a plan for paying off your unsecured debt in three to five years and to build an emergency savings fund so you aren’t right back where you started. There is a mathematically optimal way to pay off debts – starting with the highest rate debt first. The key to success here is to have a written plan you can stick with.

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This credit card article was written by Gerri Detweiler.