Debt consolidation loans are personal loans used to merge high interest debts such as credit cards, payday loans or other bills into a brand new fixed rate loan. After you receive the funds from this loan, they are used to pay off your other debts. If you pay off the loan on time, get a lower interest rate, and don’t incur any additional debt that you can’t handle, you might be able to pay off your debt faster and save a ton of money on interest.
However, while using these loans is a good way to consolidate payments and hopefully lower the interest rate on your debt, there are several debt consolidation loan alternatives for people who don’t. may not qualify for a debt consolidation loan or those looking for lower interest rates. .
Debt Consolidation Loan Alternatives
A debt consolidation loan is not for everyone. Since debt consolidation loans are unsecured personal loans, lenders may have stricter eligibility criteria or the loans may not be large enough for the types of debts you are trying to consolidate. Here are some debt consolidation loan alternatives:
- Balance Transfer Credit Card: A balance transfer card allows you to transfer debt from other credit cards – usually credit cards from other companies only – or use a balance transfer check to combine other forms of debt to one 0% interest rate. This promotional low rate period typically lasts 12-21 months, and a good to excellent credit rating is required for approval. Once the introductory period is over, you will be responsible for paying the card’s standard interest rate on the remaining balance. Additionally, most cards will charge you a balance transfer fee on the total amount you transfer, usually 2-5%.
- Home Equity Loan or HELOC: Home equity loans and home equity lines of credit (HELOCs) allow you to borrow against the equity in your home. While a home equity loan has fixed monthly payments at a fixed interest rate, a HELOC works like a credit card and has a variable interest rate. Both can be used to consolidate high-interest debt, but you risk losing your home if you can’t pay them off. Also, both require you to have some equity in your home. In comparison to debt consolidation loans, home equity loans and HELOCs often have longer repayment periods, larger loan amounts and lower interest rates.
- Refinancing by collection: A cash-out refinance replaces your existing mortgage with a brand new mortgage for an amount greater than your current outstanding balance. You can withdraw the difference between the two balances and use it to improve your home or consolidate your debts. As with using a home equity loan or HELOC, you risk losing your home if you cannot repay your new loan.
- Debt settlement: Debt settlement takes place when you negotiate with your lender to pay less than what is owed to settle the debt. You can negotiate with the debtor yourself or pay a fee to a debt settlement company or lawyer to negotiate on your behalf. Even if you, a lawyer, or a business are successful in negotiating a settlement, your credit score can take a hit.
- Bankruptcy: Filing for bankruptcy involves going to federal court to have your debts canceled or reorganized to give you time to pay them off. While you can pay off your medical debt, personal loans, and credit card debt in the event of bankruptcy, paying off your student loans and tax debt is incredibly difficult. Before choosing this alternative, keep in mind that your credit score will take a hit; it can take years for it to recover.
The bottom line
While using a debt consolidation loan to merge your high-interest debts might make financial sense if you can get a lower interest rate, it’s not your only option. In some cases, choosing an alternate route may be a better choice. For example, you might be able to get a lower rate by taking out a home equity loan, since it’s a secured loan backed against your home.
However, it is also important to know the risks involved in choosing such an alternative. Shop around the different options and compare interest rates, repayment terms, and the trade-offs you’ll make with each before continuing.