What Is Debt Consolidation? How Does It Differ From Debt Relief?
Debt consolidation is just what it sounds like — you take all of your monthly debts and consolidate them into just one monthly payment.
Both debt consolidation and debt relief have the ultimate goal of getting you out of debt. The main difference is debt relief aims to reduce your overall debt, while debt consolidation reduces the number of payments you have to make each month and may lower your interest rate.
There are several ways to accomplish debt consolidation:
Debt Consolidation Loan
What It Is: A loan that you take out to cover your other debts. After you pay off each of your individual creditors, you would then focus on just paying back the amount you owe on the loan.
Who Can Use It: Anyone with a good credit score. If your credit score is below average, you may not qualify for a loan.
Common Advantages: You can get a lower interest rate, which could save you money in the long term if you have high-interest credit cards or loans. You can deal with only a single larger creditor instead of multiple.
Common Disadvantages: A loan may still take a long time to pay off — sometimes 5 years or more. Remember that you’ll also be paying interest on the loan, so the longer it takes you to pay off, the more you’ll have to pay, which may mean that you’re not saving much money.
Balance Transfer Credit Card
What It Is: A credit card offering a low or 0% interest rate for a fixed period of time. If you have credit cards with high interest rates, this is one way to consolidate the balances and reduce the amount of interest you would pay.
Who Can Use it: If you have good to excellent credit, you may be able to open another credit card. However, you may not be able to open a balance transfer card from the same credit card company that you currently have a balance with.
Common Advantages: It allows you to pay off your debt faster by saving money on interest payments.
Common Disadvantages: Most cards charge balance transfer fees which might range from about 3-5% of the amount of debt that you are transferring. If you are transferring multiple high balances to a new card, you may want to work out whether it would save you money in the long run. When the introductory period is over, the interest rate may go up to a much higher percentage.
Cash-Out Refinance and Home Equity Line of Credit (HELOC)
What It Is: These are two different types of second mortgages which borrow against the equity you have in your home.
Who Can Use It: If you currently have a mortgage, this may be an option available to you.
Common Advantages: It can give you either a lump sum (cash-out refinance) or a revolving line of credit (HELOC) to pay down your debts. With a refinance, you may also be able to get a lower interest rate than most credit cards.
Common Disadvantages: Some refinance loans and HELOCs have variable interest rates, which means that you could end up paying more later. This option is also considered riskier since you are exchanging unsecured debt for secured debt, essentially putting your house on the line if you are unable to make payments.
Is Debt Consolidation Right for Me?
Many of the options for debt consolidation require you to have good credit. You will also need to be able to pay off your new loan or credit card in a certain period of time, or you will end up paying more in interest. You should consult with an independent financial advisor to determine if debt consolidation is the right option for you.