Debt Consolidation: How it Works
Debt Consolidation works by taking all of the unsecured debt an individual owes and combining it into one monthly payment. The type of debt consolidation plan used determines whether the accounts are paid in full through a loan, or if the creditors owed are paid monthly through one payment source.
Money Fit offers debt consolidation without a loan, meaning that we work with your unsecured debt, contact your creditors to achieve the best interest rates and reduced payment amounts available, then consolidate all of your debt into one lower monthly payment. Let’s look at the types of debt consolidation in a bit more detail:
Types of Debt Consolidation
Instead of relying on a loan, that can carry various potential financial risks that we’ll describe later, this form of debt consolidation combines your unsecured debt into one monthly payment. Consumer Credit Counseling agencies have offered this nonprofit service for decades.
Debt Consolidation without a Loan
An individual in need of debt relief schedules an appointment with a nonprofit, certified consumer credit counselor. During the appointment, the counselor reviews specific items of the individual’s current personal finances such as their household budget, their income, and expenses, as well as assets and liabilities. From there, the counselor may determine there is a benefit to participating with the organization's debt consolidation plan.
The organization will then contact the individual’s creditors, seeking to reduce monthly payment requirements, lower or waive interest rates and put a stop to any late or over-the-limit fees. Once all of the debt is combined and a new single monthly payment is made, the organization with send payments on behalf of their new client to each creditor. These accounts are closed to further charging to avoid extending the repayment terms and compiling more debt.
Debt Consolidation with a Loan
Many financial institutions offer debt consolidation loans for people looking to wipe out their debt quickly. Most of the time, the bank or lender will offer a favorable interest rate with the entire agreement based upon the premise of the individual getting out of debt.
Unfortunately, what often happens, is that since the original accounts aren’t closed, individuals now find themselves in the tough position of accumulating their original debt on their original credit cards and then being responsible for paying off their new consolidation loan. This can become especially problematic when the original debt consolidation loan is attached to something with a collateral value such as a home.
How to Know Which Type Can Help You
There is the concern of qualifying for a debt consolidation loan in the first place. If you have a low credit score or a high amount of unsecured debt, the chances of receiving a loan with favorable rates are diminished.
Part of the decision-making process comes down to your ambitions. Debt consolidation, with or without a loan, can offer short and long-term relief, but the degrees can be different. It’s important to understand what each one brings to the table and then make an informed decision about how to proceed.
We strongly recommend speaking to a certified credit counselor first before deciding which debt consolidation program will work best for you. Often times a credit counselor may find a better solution than debt consolidation, such as repaying your debt on your own, by making some adjustments. They are skilled at budgeting and more often than not, can assist others without enrolling them into a debt consolidation plan.
Ultimately debt consolidation is about reducing the burden of debt. There are many ways an individual can manage the repayment of debt so it’s exceptionally important to make the right decisions up front. Choosing a poor matching method can have long-term negative financial implications. Taking an active role in defeating your debt can be rewarding, informative and educational. The lessons learned can help guide you on your path to financial independence.
WILL DEBT CONSOLIDATION HURT MY CREDIT SCORE?
Both types of debt consolidation may have an impact on your credit score, especially early on. Though, typically, a debt consolidation loan can have less impact if an individual doesn’t use their credit cards and accumulate more debt.
A debt consolidation program without a loan can have an impact early on due to accounts being closed to further charging. This is typically a brief impact due to the account balances going down instead of either staying the same or increasing. Balance ratios play a large role in the credit score formula.
HOW LONG DOES DEBT CONSOLIDATION TAKE?
Typical debt consolidation payment terms last between 3 to 5 years. Repayment time varies and there are several methods that are commonly used to expedite the process. See: How to Speed Up Paying Off Debt for ideas on how to pay your debt off sooner.
IS DEBT CONSOLIDATION SAFE?
Debt consolidation can be a safe alternative in comparison to other courses of action. It can be far less damaging to an individual’s credit, and less risky overall, than repayment through debt settlement or bankruptcy.
One of the biggest risks of debt consolidation comes from the potential for mismanagement by the consumer who charges up original debt or opens new lines of credit and adds to their overall financial burden. Ultimately, Do-It-Yourself consolidation or debt repayment is typically preferred but it isn’t always practical.
HOW MUCH DOES IT COST TO CONSOLIDATE MY DEBT?
The costs of debt consolidation can vary drastically. Programs that don’t rely upon a loan will range from approximately $50.00 to $100.00 for enrollment fees and an average of $25 to $50 dollars for a monthly fee. With a loan, it depends upon the interest rate and monthly payment required to satisfy the loan terms.
WHAT ARE THE DISADVANTAGES OF DEBT CONSOLIDATION?
One of the biggest disadvantages comes from the closure of unsecured accounts when utilizing programs that don’t rely upon a loan and the fees that are charged. While the fees often less than that of a debt consolidation loan, that isn’t always the case.
As for debt consolidation with a loan, the disadvantages can be the costs, repayment terms and the potential for adding to your debt load rather than reducing and eliminating it.
When It’s Better To Do-It-Yourself
You may find, that after looking into debt consolidation, that you, in fact, can repay your debt on your own by making tweaks and adjustments to your spending habits, your repayment strategy (such as the debt snowball method) and budgeting efforts. By refocusing on your debt and repaying on your own you may be able to avoid additional fees or adverse changes to your credit profile.
Give us a call if you have any questions or would like to receive your free consultation. You can also reach out to organizations like the FCAA (Financial Counseling Association of America) and get connecting with a variety of nonprofit credit and debt counseling agencies.