The Pros and Cons of Debt Consolidation

When facing multiple debt accounts through credit cards, rental or mortgage contracts, auto financing or other credit lines, debt consolidation may be a good idea.

Debt consolidation is the process of combining a person’s debts into one large debt to help the person better manage his or her repayment options. There are several ways to consolidate a person’s debt depending on his or her financial history. Both public and private lenders allow for the consolidation of most types of debt.

Not all debt consolidation plans are created equally. Depending on how the consolidation plan is structured, a consumer’s credit score may get worse before it gets better when consolidating. However, grouping multiple debts into one can make it significantly easier to stay on top of payments and manage interest rates in a way that is beneficial for a person’s credit history.

Keep reading to learn more important the pros and cons of using debt consolidation services in the U.S.

What is debt consolidation?

There are multiple types of debt consolidation programs available to consumers today. The specific debt consolidation programs that a person can qualify for depend on what sort of debt and credit lines the consumer would like to combine.

Through debt consolidation, a person’s multiple debts are paid for all at once by a new lender who provides the person with a single new loan to cover all of his or her debts. In most cases, consumers can consolidate credit card debt, car financing, student loans, tax fees due to the Internal Revenue Service (IRS) and more.

The right debt consolidation program can be very helpful to people who find themselves in a variety of situations. A common reason consumers seek out debt consolidation is because they are having trouble making several payments on multiple credit lines.

Another reason many people wish to consolidate is to save on the average interest paid on some of their more expensive loans or financing.

In many cases, debt consolidation can help a consumer reduce the amount of time it takes him or her to pay all of his or her debt and as a result decrease the overall amount of interest and other fees paid. Some debt consolidation providers help consumers work out a settlement plan to reduce the amount due on individuals credit lines as well.

Debt Consolidation for Student Loans

Student loans are some of the most common types of credit accounts that American consumers consolidate. Combining multiple student loans makes it easier not only to stay on top of each loan payment, it can also take advantage of a more favorable interest rate depending on the market and the conditions of the loans. If the majority of a person’s student loans are at a lower rate than a few outliers, consolidating can help save interest on the more expensive loans by lowering their overall interest due.

The U.S. Department of Education helps many student loan holders consolidate multiple eligible loans through their Direct Loans program. Through Direct Loans, loan holders can combine all of their payments into one monthly fee and choose what type of payment plan they want to sign up for.

Consumers can choose to pay a set amount every month, base their payment on their recent income, request a pause in billing due to a specific hardship and more through this agency. Unlike most private debt consolidation companies, working with Direct Loans does not cost consumers any fees.

The federal government offers some special student debt relief programs to consumers that fit into certain categories. For example, teachers and several other groups of civil servants can qualify for the Public Service Loan Forgiveness (PSLF) program.

This consolidation program works through the government’s Direct Loans platform to help qualified consumers combine their existing student debt and get a significant portion of it forgiven after a certain number of years of service and loan payments. Applicants to this program must also be employed by one of the following types of employers:

  • Federal, state, local or tribal level state and federal organizations
  • Lawfully tax exempt not-for-profit organizations that are.
  • Not-for-profit organizations that are not tax exempt but offer certain services to the public
  • AmeriCorps
  • Peace Corps

Debt Consolidation of Personal Accounts

Today, credit card debt and similar types of credit lines are the top source of debt for Americans living throughout the country. Looking into debt consolidation programs can be very helpful to consumers who are juggling several high interest credit cards and other bills.

Most debt consolidation programs will be able to manage several accounts and help consumers understand how to maximize their debt payoff strategy.

Consumers who have a decent credit score can often qualify for personal debt consolidation plans at a much more favorable rate than the average credit card. Unlike credit cards, debt consolidation loans can offer consumers a fixed rate loan whose fees do not increase over time and which is easier to predict overall loan cost.

Unlike some other forms of debt consolidation, some consumers with poor credit may not qualify for a personal loan consolidation program. Many debt consolidation providers will require a consumer to be able to demonstrate having a regular income in order to participate. In addition, many lenders require that consumers can demonstrate holding less than 50% of their income in debt.

Credit Card Debt Consolidation

Getting a new loan to consolidate credit cards is not the only way consumers can save on their credit card debt. Opening a new credit card with a generous balance transfer rate lasting at least one year can help consumers facing debt that can be realistically paid off in the short-term. Many private banks and lenders offer cards with balance transfer discounts, offering 0% interest for a number of months or reduced transfer fees for an initial period of time.

Some consumers also look into applying for a home equity loan or 401(k) loan to consolidate their personal debt if in possession of the necessary financial products.

In order to take advantage of these offers, a consumer must already possess property or retirement assets that they can use as insurance against defaulting on the loan. Because the consumer’s personal property is used as collateral with these types of loans, only consumers who are sure they can stay on top of their loan payments are encouraged to apply.

Debt relief organizations that promote debt consolidation and better money management are often a bit different than traditional consolidation programs offered by private lenders. Some of the most popular debt relief organizations in the country do not actually offer consolidation loans to cover the costs of a client’s debt, but instead help the consumer negotiate settlements on their accounts.

Freedom Debt Relief, one of the most popular debt relief organizations in the country, helps consumers consolidate their debt by encouraging them to collectively default on all of their credit lines at once. After the creditors have begun collection proceedings, the company negotiates settlements at lower amounts than the original amount of the debt.

After paying additional interest for the period of time that the accounts were in default and paying the average 23% management fees, the amount of savings for consumers can be negligible. Consumers are encouraged to look into the history and experience reviews of any debt consolidation company they are considering working with before signing up for a program.

How to Use Debt Consolidation to Get Out of Debt

Many American consumers have benefited from signing up for the right debt consolidation program to help them better manage their credit lines and debt amounts. Not all debt consolidation providers are created equally, however, and consumers should make sure that whatever program they choose will have the intended effects on their credit score now and in the future.

No matter how a consumer decides to pay of her or his debt, making regular payments and minimizing the amount of interest paid on all credit lines are the basic steps towards smarter spending.

Consumers should also look into the actual cost of enrollment for different programs. As previously mentioned, publicly offered student loan consolidation programs are usually free from costs and fees, but most consolidation programs offered private for credit card lines and similar financing generally carry a significant fee.

Credit holders looking to consolidate should speak with multiple consolidation providers before settling on the program that is right for their needs.