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Dealing with debt can be a frustrating and emotionally tiring experience. Regardless of whether you have high credit card balances, persistent medical debt or a crippling mortgage, your financial obligations can interfere with your ability to lead a balanced life. If you think you cannot pay your debts by yourself, you might consider an option that has provided relief to hundreds of thousands of other Americans: a debt consolidation loan, also known as a refinancing loan.

These loans can be of great help to borrowers who owe significant cash – but they take risks. It is important to understand the disadvantages and consider all the alternatives before deciding if a debt consolidation loan is right for you.

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A debt consolidation at ConsolidationNow logo pays off existing debts and combines these balances into a single monthly bill with a new interest rate. The goal is to obtain debt relief and reduce the total interest rate on your outstanding obligations.

Who offers debt consolidation loans?

Who offers debt consolidation loans?

Different types of financial institutions offer debt consolidation loans:

Specialized lenders. Many debt consolidation loan providers are specialized lenders (also known as finance companies) that do not accept deposits like traditional banks and credit unions. They can pay the old creditors directly and then send you a monthly bill for the balance, or send you a check or a direct deposit for the full amount. Loans from financial companies generally start at the primary rate (currently 3, 25%) plus 5%. Their credit history requirements may be less stringent than those of traditional banks; however, their rates may be higher for borrowers with average credit. Loan limits vary by company, but $ 25,000 is common.

Credit unions. Credit unions also offer debt consolidation loans, with terms from 12 to 60 months, often at discounted or fixed rates for members.

Payday Lenders. Unlike other types of debt consolidation loans, an unsecured payday loan does not require a credit check. Instead of paying your individual debts directly, payday lenders pay you in cash and allow you to settle them yourself. Since these loans have high-interest rates (15% and above, or the main rate plus 12%) and repayment windows sometimes even a few weeks, they are generally not recommended for large debt loads. Your loan power is also limited by your monthly income.

Peer-to-peer loan services. Peer-to-peer (P2P) lending services, facilitate unsecured loans between individuals and reduce the interest charged. The rates depend on your credit history and can range from 6% (prime + 3%) for borrowers with excellent credit, to over 30% for those on the other side of the spectrum. The terms of the loan can vary from 36 to 60 months, with larger amounts receiving longer terms.

Personal credit lines from a bank or credit union . Many banks and credit unions also offer unsecured lines of credit to qualified borrowers. Rates and limits are similar to the debt consolidation loans of banks and credit unions, but credit lines generally do not have to be repaid within 60 months.

These loans can be unsecured, which means that they are guaranteed only by your promise to repay, or guaranteed, which means that they are tied to a physical asset – more often your home, but sometimes a retirement account, insurance policy. life insurance, car or other valuable personal possession. Unsecured loans can only be applied to unsecured debts, such as credit cards and medical expenses. The proceeds from secured loans can be applied to a wider range of bonds, including mortgages and car loans. Secured debt consolidation loans tend to have lower interest rates than unsecured ones.

Is a debt consolidation loan right for you?

Is a debt consolidation loan right for you?

Both secured and unsecured debt consolidation loans have common advantages: simplify the monthly debt payment program, lower interest rates on old credit cards and help rebuild credit if payments can be made on time. They also share a common disadvantage: while taking a debt consolidation loan does not automatically damage your credit score, simultaneously canceling all credit cards after using a loan to pay their balances – a common mistake – it can lower it up to 50 points per card, depending on your previous credit history.

Before making any decision, also consider these specific advantages and disadvantages of the category:

Unsecured loan advantage

No collateral requirements. Unsecured debt consolidation loans do not require you to put up assets as collateral, so you don’t risk losing any physical property if you can’t repay.

Disadvantages of unsecured loan

Higher interest rates. Since they are not backed by collateral, unsecured debt consolidation loans are much more risky for lenders. As such, they usually come with higher interest rates. If you have an excellent credit score (780+), the difference can be manageable compared to what you pay with a secured loan. With a lower credit score, your loan could be much more expensive than a secured loan, although it could still be better than the card it replaces. If you can find the necessary collateral, a secured loan can help you increase the difference between the old credit card rate and the debt consolidation loan rate. Note that rates on P2P loans can vary widely, ranging from an APR of 6,

Strict credit requirements. If your credit score is below 650, it may be difficult to qualify for an unsecured loan at a bank or credit union. While P2P lenders and finance companies lend to borrowers with lower credit scores, their rates are probably higher than those of a secured loan, and possibly even higher than the old credit card. Your credit score also affects the size of your loan, so while you might qualify for a loan of $ 30,000 or $ 50,000 if you have excellent credit (780+), you can benefit from much less without that advantage.

Benefits Guaranteed loans

Lower interest rates. Although the exact rate depends on your credit score, loan size and position, your secured debt consolidation loan will probably be cheaper than an unsecured loan. For example, the APRs on a $ 30,000 domestic equity credit line (HELOC) range from 3.5% to 6% for borrowers with an average credit score of 700.

Less stringent qualification requirements. Since your credit institution can get back your collateral in the event of a default on your loan, you don’t need a strong credit score. Some credit institutions accept a score of just 500. However, the amount you are eligible for is limited by the value of your guarantee.

Better repayment terms. Some secured loans have lower repayment requirements – sometimes domestic equity lines of credit keep the outstanding balances up to 25 years. This can further reduce your monthly obligations and increase the likelihood that you can pay your bills.

Greater debt limits. Depending on the value of the guarantee, a larger loan may be approved. Considering that lenders require excellent credit for unsecured loans of $ 30,000 or more, you can borrow 85% of your home’s net worth for a secured loan.

The guaranteed disadvantage of the loan

The potential loss of assets. Whenever you put up an asset as collateral – whether it’s your home, an insurance policy, or a part of your retirement plan – you agree to give it up if you do it on your loan. An unexpected loss of a job, medical expenses or family death could jeopardize your plans.

Since debt consolidation loans are issued by a wide range of financial institutions, it is advisable to examine the lenders before making a decision. Use your local Better Business Bureau or consumer protection office for research, and stay away from organizations with a history of past complaints or lawsuits.

Popular alternatives

debt consolidation loan

If you are considering a debt consolidation loan, consult these alternatives before making a final decision:

Credit Counseling. Credit counseling organizations, which often receive funding from banks and other financial institutions, offer consumers free or low-cost financial education services. Many also offer debt management plans, which are voluntary agreements between borrowers and creditors that can help reduce interest rates, waive penalties and consolidate balances on a single monthly bill. If you need to cancel credit cards as part of your debt management plan, your credit score may drop – how much depends on how many other credit cards you have and your total debt/credit ratio. A record of each cancellation can remain on your credit report for up to seven years.

Debt settlement programs. Similar to a debt management plan, a debt settlement program is mediated by an intermediary organization that negotiates balance reductions with creditors. The process can take up to four years, during which monthly deposits are made in a guarantee account in preparation for a lump sum of all participating debts. Like debt management, participation in debt settlement is voluntary, and the process can ding your credit score from anywhere from 50 to 150 points – the hit is bigger if you previously had good credit. For each debt settled, the record appears on your credit report for up to seven years.

Bankruptcy reorganization or liquidation. There are two main types of consumer bankruptcy, both supervised by a judge: Chapter 13, or reorganization, and Chapter 7, or liquidation. The first creates a new payment plan for unsecured debts, while the second clear many of the unsecured debts and may require you to sell assets to repay secured creditors. Creditors are legally obliged to participate, even if not all debts can be discharged in bankruptcy. Bankruptcy can have a serious effect on your credit score and requires seven (chapter 13) to ten (chapter 7) years to clear your record. The impact varies depending on your current credit score and recent history but can vary from less than 100 points to over 200 points. Like debt settlement,

Balance transfers by credit card. If you’re mainly struggling with credit card debt, transferring your high-interest balances to a card with a lower interest rate can make your situation more manageable. Many credit card companies offer introductory balance transfer fees, often as high as 0%, for new customers. These tariffs can last from 6 to 24 months, after which they are restored to the normal rate of the card. Furthermore, you are limited by the credit line for which you have been approved.

Final word

Debt consolidation loans can help you pay your high-interest credit card bills, medical debts and other obligations, and bring your balances into a single monthly payment, usually with a lower interest rate. If used judiciously, they can significantly reduce the total cost of debt and help you create a sustainable budget.

However, debt consolidation loans have many potential pitfalls, including the risk of losing assets on secured loans. Do not take a debt consolidation loan without weighing other options, such as credit card balance transfers and credit counseling. And of course, talk to a financial advisor if you feel you need further assistance.