Most significantly, debt settlement involves hiring and paying a third-party company to negotiate a lump-sum payment that each of your creditors will accept in lieu of paying the total outstanding balance. In contrast, debt consolidation requires the borrower to pay their full debt balances using funds from a new loan. Instead, the debt consolidation process requires borrowers to take inventory of their debts and develop a plan to pay them off in a more streamlined—often less expensive—way.
When consolidating debt, a borrower applies for a personal loan, balance transfer credit card or another consolidation tool through their bank or another lender. While debt consolidation often lowers the amount a borrower owes each month, it accomplishes this by extending the loan period of the consolidated loans.
Consolidating debts also streamlines payments and makes it easier to manage finances—especially for borrowers who struggle to manage their money. Because debt consolidation can be a way to manage multiple types of debt, there are several types of debt consolidation.
Here are the different types of debt consolidation to meet individual borrower needs:. These personal loans are typically available through traditional banks and credit unions, but there are a number of online lenders that also specialize in debt consolidation loans. When shopping for a consolidation loan, take time to compare available loan terms, fees and interest rates.
Many lenders offer an online prequalification process that lets borrowers see what interest rate they may qualify for based on a soft credit check, which should be your first step when getting a debt consolidation loan. A credit card balance transfer occurs when a borrower takes out a new credit card—preferably with a low introductory interest rate—and transfers all of his existing balances to the new card. When deciding whether to transfer your credit card balances to a new card, consider available interest rates, applicable transfer fees, transfer deadlines and consequences of missing a payment.
Student loan consolidation is the process of combining multiple federal student loans into a single, government-backed loan. In addition to lowering and simplifying their monthly payments, graduates may be able to take advantage of borrower protections like Public Service Loan Forgiveness PSLF. The money is issued in a lump sum and the borrower can use the cash to pay off—or consolidate—existing debts. Once funds are dispersed, the borrower must pay interest on the entire loan amount, but—because the loan is collateralized by their home—is likely to qualify for a much lower interest rate than available with a debt consolidation loan.
A cash-out refinance occurs when a borrower refinances his mortgage for more than the outstanding balance of the loan. This enables the borrower to withdraw the difference in cash and use it to pay off other outstanding debts. The borrower can then roll their other debt payments into a single payment with his mortgage. And, because the loans are rolled into a secured mortgage, the interest rate is likely much lower than on the original debts. Debt consolidation may be a good idea if:.
It does this by paying off high interest debt with a lower interest rate debt consolidation loan provided you can get approved for a low interest rate consolidation loan. It can make life easier with a smaller monthly payment. This can be true if you consolidate at a lower interest rate or have a longer period of time amortization period to repay the loan. It can pay off debt faster. However, this only works if you obtain a lower interest rate and keep your current monthly debt payment pretty much the same as it is now.
This then allows more of your monthly payment to actually pay down your debt the principal since less of the money is being eaten up by interest. How Consolidation Loans are Issued When you receive a traditional debt consolidation loan, the company lending you the money either uses the funds to pay out the debts you jointly agree will be paid off, or they deposits the funds it in your bank account and it is then your responsibility to pay out the debts or bills you wish to consolidate with the loan proceeds.
Learn More: How your credit score is calculated Collateral for a loan is an asset you can pledge as a guarantee or loan security in case you are unable to repay the loan. Is a Debt Consolidation Loan Good? Watch Out for This Trap! It Catches Most People More and more people are asking a very important question.
The Painful Reality of Debt Consolidation Loans Popular personal finance talk show host Dave Ramsey once shared the results of an American bank's study into their clients who received debt consolidation loans. Different Ways to Consolidate Debt - The Big Picture Answer to the Question "What is Debt Consolidation" When you ask "What is debt consolidation and how does it work," there can actually be a number of different ways to answer these questions.
Here are the most common ways people go about doing it these days in Canada: Don't Get Ripped Off If anyone tries to sell you a debt consolidation loan or service that costs thousands of dollars in up-front fees, walk away. Home Equity Loan — this is often called taking out a second mortgage. If you have a good amount of equity in your home the amount you own after you subtract your mortgage from the value of the home , this could be an option. This option offers the lowest interest rates when done through a normal bank or credit union.
Line of Credit — if your bank or credit union can approve you for a line of credit, you could use this to consolidate debt. Lines of credit can be secured by your home or your bank may offer you an unsecured one if you have good credit and a good income.
The downside of consolidating this way is that you have to discipline yourself to pay a set amount each month that is much higher than your minimum monthly payment.
If you only pay the minimum, it will take decades to pay off. Debt Consolidation Loan Through a Bank or Credit Union — if you have a decent credit score and have some good collateral security for the loan to offer, this could be an option.
This option typically offers the next best interest rates after mortgages and lines of credit. Credit Card Balance Transfer — credit cards often offer low interest rate balance transfers as a means of debt consolidation. While this can be very attractive, it can end up being a bit of a trap.
This will double your debt if you take 7 years to pay it off. The down side of doing this is that you really have to discipline yourself to pay a set amount every month that is a lot more than the minimum payment to ensure you get the balance paid off in a reasonable length of time.
These repayment plans eliminate interest, consolidate debt payments into one affordable monthly payment, and ensure you are debt free within 5 years. So, yes, your credit score will suffer if you choose debt consolidation. But debt settlement is when you hire a company to negotiate a lump-sum payment with your creditors for less than what you owe.
Sounds good, right? Someone does the dirty work and you get to keep more of your paycheck? Not so fast. Once you fork over the fee, they promise to negotiate with your creditors and settle those debts on your behalf. Most of the time, these companies will just take your money and run—leaving you on the hook for late fees and additional interest payments on debt they promised to help you pay!
Debt settlement is a scam, and any debt relief company that charges you before they actually settle or reduce your debt is in violation of the Federal Trade Commission. List your debts smallest to largest no matter the interest rate. Cut back your spending , get on a budget , make extra money , etc. Once that debt is gone, take all the money you were paying toward it and apply it to the second-smallest debt. Keep making minimum payments on the rest.
Keep going until every single debt is gone. Not somewhere else with a different interest rate. Financial Peace University shows you how to attack your debt and save real money.
Know Yourself, Know Your Money helps you see how your past and your personality affect how you deal with money today. You suck, debt. Ramsey Solutions has been committed to helping people regain control of their money, build wealth, grow their leadership skills, and enhance their lives through personal development since Millions of people have used our financial advice through 22 books including 12 national bestsellers published by Ramsey Press, as well as two syndicated radio shows and 10 podcasts, which have over 17 million weekly listeners.
Guided Plans. Trusted Pros. Free Tools. Questions answered in this article: What Is Debt Consolidation? About the author Ramsey Solutions. More Articles From Ramsey Solutions. Learn More. Answer a few questions, and we'll create a plan tailored just for you.
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