Loan consolidation may sound like a great way to gain greater control of your debt, but it’s not always the right option in all situations. Follow these four steps to decide what’s best for you:
1. Understand the Impact.
When you consolidate debt, you typically seek to lower the interest rate you’re paying on outstanding balances. That’s the good news, but the benefit may be lost if the loan has a longer repayment timeframe and you end up taking more time to pay it off. The longer it takes you to get rid of the balance, the more interest you will pay. Period. As a result, no matter how appealing and convenient consolidation may seem, it could end up costing you more.
2. Run the Numbers.
Consider whether there are better alternatives to consolidation. You may be able to renegotiate the terms of some of your loans by contacting your creditors directly, avoiding potential consolidation fees.
Another consideration is whether you should include all your loans in a consolidation. The answer may be no. For example, let’s say you have several credit cards with rates of 16% to 18%, plus a federal student loan with a 4% interest rate. You find a balance transfer card that will have a rate of 12% after an initial nine-month low-rate promotional period. Transferring your credit card balances to that card will lower the rates you pay on your credit cards, but the 12% rate will be much higher than your student loan rate. For that reason, it’s likely best to leave low-interest loans out of the consolidation.
3. Know Your Choices.
There are several options for consolidation, so don’t make your decision before you have all the information you need. Possibilities include:
- A balance transfer. You can pool your money and move it to a balance transfer account or credit card. You can also consolidate your loans with a line of credit, such as a home equity loan.
- Debt settlement companies. These organizations negotiate with your creditors to see if they will let you pay a lump sum that’s less than your total outstanding debt. You deposit money in a savings amount every month to accumulate that lump sum. When working with one of these companies, ask:
- How long you will have to make payments. Be sure that you will be able to make all the payments necessary to settle your debt.
- Whether you will be advised to stop paying off creditors while building the lump sum. If so, you could face late fees and penalties, and a drop in your credit score. Think twice about working with companies that don’t explain the consequences of stopping debt payments.
- What fees the company will charge. Be cautious if a company asks you to pay them fees before you settle your debt, something that’s not allowed under Federal Trade Commission rules. If a company has an aggressive sales pitch or makes offers that sound too good to be true, walk away.
- You can learn more information about specific companies from your state attorney general’s office, a local consumer protection agency or reviews on the company’s site.
- A debt management plan. Typically developed with your creditors and a nonprofit debt counseling agency, these plans aim to consolidate your loans at a lower rate and for a longer repayment period. The agency usually receives a small fee.
4. Avoid Running Up New Debt
It may be a relief to receive only one bill each month for your debts, and to have the chance to reduce your interest rate or monthly payment. However, resist the urge to reward yourself with a splurge. If you stick to a reasonable budget and to making regular monthly payments, you’ll soon be able to enjoy the chance to be debt free.
Your local CPA can help walk through all consolidation options available to help identify the best option for your financial plan.