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Debt consolidation is combining multiple debts into one loan to reduce the number of bills you pay each month. Ideally, when consolidating debt, you also reduce the interest rate you pay and you can ultimately pay off the debt faster.
If you are considering debt consolidationYou should start by deciding which method is best and evaluating your financial and credit health to determine if you are a good candidate for debt consolidation. Once you’ve taken these steps, you can move on to researching and evaluating lenders to find the best solution to help you pay off those crippling debt balances sooner.
Identify the type of debt consolidation that suits you best
The first step is to evaluate debt consolidation options and select the method that is best for you. Common methods include:
- Personal loan: Many lenders offer debt consolidation loans or personal loans designed to help you pay off your debts faster and save a lot of interest. Debt consolidation loans usually come with a fixed interest rate and a loan term of 1 to 10 years. You are free to use the funds as you see fit, but the idea is to pay off your debt balance with the loan proceeds.
- Zero APR credit card: Also known as balance transfer credit cards, these debt products can help you save a significant amount in interest and eliminate high-interest debt balances faster. They are generally reserved for consumers with a good or excellent credit rating. You should only consider this option if you can repay the balances you transfer to the card during the introductory period. Otherwise, you could end up paying a fortune in interest.
- Home Equity Loan: You can convert up to 85% of your home equity into cash and use it to consolidate your debt with a home equity loan. It acts like a second mortgage and comes with a repayment period of between five and 30 years. The interest rate is also fixed and lower than most credit cards, but the main drawback is that your home guarantees these loan products. Therefore, you could lose your property to foreclosure if you fall behind on loan repayments.
- Home Equity Line of Credit (HELOC): A HELOC is a home equity loan, but you will not receive the loan proceeds in a lump sum. Instead, you’ll have access to a pool of money that you can draw on as needed during the 10-year draw period. Interest-only payments are also required during the drawdown period on most HELOCs. Once completed, you will repay in monthly installments over a term of up to 20 years. The amount of the monthly payment can fluctuate since the interest rate on HELOCs is generally variable.
It’s important to select the best option for your needs, as this will help determine the type of lender you choose. Not all lenders offer the same borrowing options. Once you’ve decided on a consolidation option, you can analyze each lender’s interest rates, loan terms, and fees to determine which offers make the most financial sense for your goals.
Determine your qualifications
Lenders want to know that you are creditworthy and have the means to make timely payments on the loan or credit card you are using to consolidate your debt. This means you can expect the lender to assess your credit score and credit history to determine if you have a history of responsible bill paying.
Lenders will also look at your debt-to-equity ratio to determine if you can afford monthly repayments and if you’re not taking on more than you can handle. Lenders also want to see verifiable proof of income and will be looking for long-term financial stability.
Also, be aware that the most competitive interest rates are generally reserved for borrowers with a good or excellent credit rating. A lower credit score doesn’t always mean you’ll automatically be denied a loan or credit card. Still, you will usually get a high interest rate if approved to offset the risk of default posed to the lender or creditor.
Ultimately, you may find that it doesn’t make sense to consolidate your debt if you have bad credit if you only qualify for a higher rate than you’re currently paying.
Shop around for lenders
Look for lenders that offer the type of debt consolidation you are looking for. Most offer online prequalification with a flexible credit application. If you’re considering a debt consolidation loan, you’ll also get an overview of potential loan costs to compare your options with.
In addition to checking online lenders when shopping, it may be a good idea to check the options available from banks or credit unions. You may qualify for more favorable loan terms if you have a pre-existing relationship with a bank or lender.
Regardless of the type of lenders you include on your shortlist, prequalification takes the guesswork out of finding lenders willing to work with you. Plus, you’ll avoid going to lenders who might deny you a loan or credit card and get an unnecessary credit check.
Assess the lender
Once you have a shortlist of at least three lenders, it is a good idea to compare them side by side and compare the factors below, which will impact the overall cost of your loan, your ability manage it and the customer service you receive:
- Annual Percentage Rates (APR): This figure represents the actual annual cost of borrowing. It includes interest and fees determined by your credit score and debt-to-equity ratio. Knowing this information for each loan option can help you assess which one will cost the least.
- Lender fees: Some lenders charge origination fees ranging from 1-10% of the loan amount. Even if the APR is on the lower end, high origination fees might make a different loan product the more practical choice. Similar to APR rates, knowing each lender’s fees can help you determine which loan is more expensive or best suited for you.
- Characteristics of the lender: Top lenders also have an online dashboard where you can monitor your account, schedule payments, and chat with customer service representatives. It’s also great if free educational resources can help you manage your credit and overall financial health more effectively. Understanding the features and customer service offerings of each lender gives you a better idea of which loan will be easier to manage.
- Customer reviews: You want to select a reputable lender with a proven track record of providing quality service. Checking online reviews from past clients can be a good way to gain peace of mind before signing on the dotted line with a lender. Seeking accreditation from the Better Business Bureau (BBB) may also be a good idea.
At the end of the line
Before applying for a loan or credit card to consolidate your debt, weigh your options to decide which type of debt consolidation makes the most sense. Plus, get prequalified with at least three lenders to see potential loan quotes and compare your options. This will allow you to make an informed decision, reach your debt repayment goals faster, and save money.