What is the best way to consolidate debt?

There's more than one way to do it, and it's important to pick the one most appropriate for your situation.

By Credit.com Feb 17, 2014 3:06PM
This post comes from Gerri Detweiler at partner site Credit.com.

Credit.com on MSN MoneyDebt consolidation often seems like the perfect way to conquer your debt: consolidate your balances into a single loan and make one monthly payment until you are debt-free.

Woman using calculator on desk full of bills and statements © Sheer Photo, Inc/Photodisc/Getty ImagesWhile there may not be a single best way to consolidate debt, it is possible to narrow down the top options for your situation.

Personal loan

A personal loan is often what people have in mind when they talk about consolidating debt. The ideal solution here is a loan with a low interest rate and affordable monthly payment that you can use to pay off other high-rate debt. And this can be a great strategy, provided you can find the loan you need.

That can be a challenge, though, if your credit isn’t great. High levels of debt – especially credit cards with balances approaching your credit limits – can make it difficult to qualify for new credit.

When it works, though, it can work very well.  In particular, if you get a personal installment loan with a fixed repayment period, you will know exactly how much you have to pay each month until you are debt-free. You won’t run the risk of falling into the trap of making minimum payments and stretching out the debt for decades. Plus, carrying a balance on an installment loan may be better for your credit scores than a credit card with a high balance.

Before you start shopping for one of these loans, though, be sure to check your credit scores to see where you stand. There’s no sense in applying for loans for which you can’t qualify. Plus, knowing your score can help you identify what loans might be within your reach. Credit.com’s Credit Report Card gives you two free credit scores updated every month, plus you’ll be alerted to loans that are available through lenders who are looking for borrowers with profiles similar to yours.

When it’s best: If you can get a personal loan with a lower rate and a repayment schedule that will allow you to pay off the loan in 3-5 years, this can be an excellent option.

Credit card consolidation

Similar to a personal loan, a low-rate credit card or 0% balance transfer offer may be used to consolidate higher rate balances. But watch out: There may be a fee for the transfer (usually 2-4% of the amount transferred) and if the offer carries an introductory (“teaser”) rate, it won’t last forever. Offers with very low rates – 0% or 3.99% for example – typically last for 12-18 months. After that, the rate can jump significantly.

Another thing to keep in mind: If you use a single credit card to consolidate several other balances, you may wind up using a substantial portion of your available credit, and that can hurt your credit scores – at least until you pay it down. You will want to weigh the impact of that against the money you’ll save to decide whether it’s worth it. (You can also find out how your debt is affecting your credit scores for free by using Credit.com’s Credit Report Card.)

When it’s best: This option works best for someone who qualifies for a low-rate balance transfer offer with low transfer fee and pays off the entire debt before the teaser rate expires. It also generally works best when there is no other balance or charges on the card while the transfer is being paid off. Otherwise, multiple interest rates may make it challenging to keep track of how much you need to pay to retire the transferred balance.

Credit counseling consolidation

While credit counseling agencies don’t consolidate debt, a Debt Management Plan through one of these organizations is similar in many ways to getting a consolidation loan. If you enroll in a DMP, you’ll pay the counseling agency each month, and in turn the counseling agency pays each of your participating creditors. In addition, your interest rates may be reduced and your monthly payment should be lower as well.

According to Cambridge Credit Counseling Service, the average interest rate reduction for consumers enrolled in one of their DMPs during the second half of 2012 was 14.6 percentage points, from 22 percent down to 7.4 percent. The average monthly savings realized as a result of interest rate reductions was $139.26.

You don’t have to have good credit to qualify for a DMP, so it can be an ideal option for someone with less than stellar credit. Personalized budgeting advice should be part of the package, too, making this a good option for someone who needs expert advice.

When it’s best: A DMP works well for someone who is not able to successfully pay off their debt on their own, and needs the extra help and support a counseling agency can provide.

Loan from friends or family

A family member who is willing to lend you the money to pay off other debts may also be willing to do that at a low interest rate, and to be at least somewhat flexible with the terms. There is usually no credit check, and because these loans aren’t reported to credit reporting agencies, your credit scores might actually improve if you use one of these loans to pay off credit cards with high balances.

But if you can’t pay the loan back, you risk your relationship with the person who helped you out. Only the two of you can decide if that’s really worth it.

When it’s best: This can be an excellent option when the lender and borrower are both on the same page, and willing to put their agreement in writing to make sure there are no misunderstandings. It also helps if the lender can afford to forgive and forget the loan if the borrower can’t pay.

Retirement account loan

Have savings stashed away in a 401k, 403b or pension plan? You may be able to borrow against those funds at a low interest rate – and you pay interest back into your own account rather than to a lender. In addition, there is no credit check for one of these loans, so it’s very easy to qualify.

While that sounds easy enough, there are plenty of drawbacks. If you can’t pay back the loan as agreed, you may pay taxes, and penalties, just as if you withdrew the money from your account instead of borrowing against it. And you may jeopardize your retirement savings. After all, your money is not invested in the market where it may potentially earn higher returns.

But the biggest trap involves consumers who use retirement funds to consolidate debt but wind up in bankruptcy anyway. If you are considering a loan against retirement funds because you are struggling to pay your bills, be sure to talk with a credit counselor and bankruptcy attorney first.

When it’s best: This is the best way to consolidate debt if you can’t qualify for a low-rate consolidation loan elsewhere; you have already spoken with a credit counseling agency and bankruptcy attorney and determined those aren’t better options; and you are not at risk of being unable to pay the loan back if you leave or lose your job, for example.

As you can see, that is a pretty narrow set of circumstances – but it is intended to be. Retirement loans can be one of the cheapest ways to borrow – but can also quickly become one of the most expensive.

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Feb 17, 2014 5:20PM
Best way to deal with debt is to avoid it entirely. Shuffling payments around is nothing but a game of musical chairs..and eventually you have to pay.  Do yourself a BIG favor,and live within your means. Too bad the Federal government is spending OUR money as fast as they can print it…fools.
Feb 17, 2014 5:14PM
The more things that you own.....the more things that will own you.
Feb 22, 2014 10:11AM

Over the years I have developed a Philosophy about Credit Cards. I have a gas credit card. I put on a few bucks every month to keep it going. I have 2 Store cards that I uses a couple times a year to keep them going, never keeping a balance going for more than 3 months. I have 1 major credit card, I never put much on that and keep it paid off every 3-4 months before using it again. When buying a high priced item I pay all but a couple of hundred or so in cash. NEVER put more on a credit card than you can write a check for and pay it off at once incase there is an event in your life. Never charge anymore than you have cash on hand.

I'm rather miffed that I have to live this way so I can have that all Important but Useless Credit Rating. The only 2 things that I have Financed is a car and a home, but to get by I have to live like I do. For what, A Credit Rating!

Feb 22, 2014 9:56AM
There is not much positive to say about consolidation of loans, just means you screwed up really bad and you need help getting out of trouble.... The only thing is if you learn from it, get through it and never allow it to happen again.... otherwise the entire process is a wasteful experience for all parties. 
Feb 22, 2014 12:31PM
"Consolidation" seems like a good idea. Biggest problem with "debt consolidation" is lack of self-discipline.  If you consolidate credit card debt and don't stop using the cards, all you are doing is giving yourself more latitude to acquire more credit card debt - except now, you have debt that went from "unsecured" to "secured".  You are digging yourself a financial grave if you don't learn to exercise self-discipline with your credit card spending and your debt re-payment practices.
Feb 22, 2014 12:50PM
It all part of life,most people are in debt you have to try your best to get it under control. It very stressful,Nowadays anyone who isn't in debt is underprivileged
Feb 22, 2014 12:23PM
Do not borrow from your 401 K and stop spending past your income. It is true, the more you own, the more it owns you. The more things you have the more they may need repair or maintenance. The bigger your house, the longer it takes to clean and maintain and either you clean it or you hire someone to do it and they won't work for free. Simplify your life.
Feb 22, 2014 10:00PM
Do like our government does. Keep borrowing and spending all you can, enjoy the life of the Rich and Infamous, and find a bunch of stupid people who will let you get away with it.

Once you owe enough money, your creditors will do everything in their power to help you stay alive in hopes of collecting their interest payments..

Beware! When there's nothing left feed your cronies vociferous appetites for wealth, you become the Entree.
Feb 22, 2014 4:49PM
You want a negative hit on your credit report? Just use one of those so called credit couseling companies. It may or may not lower your score, but try to explain to the bank why you are using credit counseling and why you think the bank should give you a loan. It looks just as bad to a creditor that you are in "counseling" for your credit.
Feb 22, 2014 1:43PM
You are not as fiscally responsible as I am therefore, you deserve nothing.
Feb 22, 2014 1:49PM
When will the wheezing cut and paste geezer drop?
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