What is the best way to consolidate debt?

Personal loans affect your credit score in the short-term and in the long-term. In the short-term, a personal loan may damage your score because it causes a hard credit inquiry and increases your debt load. But in the long-term, a personal loan can either help or hurt your credit, depending largely on whether or not you pay the bills on time. Ultimately, it’s up to you how much impact the personal loan will have.… read full answer

How a Personal Loan Affects Your Credit Score:

• Does temporary damage with an initial hard inquiry. When you first apply for a personal loan, your credit score will immediately take a small hit. That’s because applying for a personal loan triggers a hard inquiry into your credit history. But this shouldn’t drop your score by more than 5 points or so, and you should be able to bounce back quickly.
• Adds to your overall debt. If you’re approved for a personal loan, you will immediately have a higher debt load, which may cause your credit score to drop in the short-term. That’s because the more debt you have, the riskier it is for banks and credit unions to lend to you.
• Reports to the major credit bureaus monthly. The banks, credit unions and online lenders that issue personal loans report payment information to the major credit bureaus on a monthly basis. If you make on-time payments, you can expect your score to increase. But if you are late or don’t pay altogether, your score will drop.
• Improves your credit mix. Proving yourself capable of managing multiple types of loans and lines of credit responsibly is good for your credit score. It shows you can be trusted to repay what you borrow in a variety of situations. So if you only have one or two other types of accounts on your credit report, such as credit cards or student loans, your score may benefit in the long run from getting the personal loan.
• Could help reduce credit utilization. Personal loans give you a lump sum up front, which you pay back in monthly installments. This is different from a credit card, where you can borrow up to a certain amount any time you want. Credit cards are known as “revolving credit,” and a big part of your credit score is how much of your revolving credit you use up each month, or your “credit utilization ratio.” Personal loans don’t count toward this ratio, so if you use them to pay off revolving debt, you can lower your ratio and improve your score.

In conclusion, as long as you’re sure to pay on time each month, a personal loan should eventually increase your score by a lot more than the initial inquiry caused it to fall. You can also avoid wasting hard inquiries by getting pre-qualified for a loan first. Pre-qualification only uses a harmless soft inquiry. And while it doesn’t guarantee approval, it will let you know if your odds are good.

The biggest pros of debt consolidation include the potential to save a lot of money and the simplicity of having fewer monthly payments to deal with. Notable cons include short-term credit score damage, the possibility of fees, and the risk of actually adding to your debt load in the long run. Plus, it’s difficult to get a good deal on debt consolidation without a credit score of 660-700 or higher.… read full answer

So, the practice of debt consolidation does indeed have both pros and cons. But the pros usually outweigh the cons, especially for people who do their research and borrow responsibly.

Top 4 Pros and Cons of Debt Consolidation

Pros of Debt Consolidation:

1. Lower APR possible. When you consolidate, you may be able to get a lower APR than the ones on your original debts, which can save you money and help you pay off the total amount more quickly.
2. One monthly payment. You will go from having multiple monthly payments to keep track of to having just one.
3. Lower likelihood of default and credit score damage. Accruing interest less quickly and only having to submit one payment help reduce the odds that you will miss payments or default. Thus, you can avoid credit score damage.
4. More time for repayment. Depending on the type of debts you consolidate, you might get a longer payoff period. For example, if you consolidate payday loans, you’ll go from owing the money in 2 - 4 weeks to having months or years to pay it off – and at much lower rates, too.
5. Could free up collateral. If you consolidate with an unsecured loan or use a credit card balance transfer to pay off a loan that’s currently secured by collateral, you will no longer be in danger of losing that collateral.

Cons of Debt Consolidation:

1. Credit score restrictions. In order to qualify for a personal loan, you’ll need a credit score of 585+. You’ll need 620+ for a home equity loan or HELOC and 700+ for a good balance transfer credit card. And those are the bare minimums – you’ll need good or excellent credit for the best APRs.
2. Lower APRs aren’t always available. Not everyone can qualify for a lower APR than they currently have, especially if their credit rating has declined since they took out the original debt.
3. Not all debts are eligible. Not all debt consolidation options support all types of debt. For example, credit card issuers often limit the types of debt that can be moved to a credit card through a balance transfer.
4. Hard inquiries hurt your credit standing. If you open a new loan or credit card, the hard inquiry triggered by the application will cause some temporary credit score damage. It’ll take a few months of timely payments to bounce back.
5. Fees could add to your costs. You may need to pay a fee in order to consolidate debt. For example, personal loans sometimes charge origination fees of 1% to 8% of the loan amount, and credit cards often charge balance transfer fees of 3% to 5% of the transferred amount.
6. Consolidation might not solve your problem: If you don’t pay the bills on schedule and adjust your everyday spending to ensure it’s sustainable, consolidation won’t pay off in the long run. That’s especially true given that it might be possible to borrow more than the amount being consolidated. Your highest priority should be getting debt-free, so you don’t need to keep refinancing over and over.

There are plenty of ways to consolidate debt, each of which has its own pros and cons. You can consolidate by getting a lump sum through a personal loan or home equity loan. Or, you can borrow up to a certain limit any time you want by taking out a home equity line of credit or doing a balance transfer to a credit card.

Advantages & Disadvantages of Popular Debt Consolidation Options:

Personal loans allow you to borrow a lump sum for 12 - 84 months without putting down any collateral. Their funds can be used for anything, including paying off old debts.

Benefits of consolidating debt with a personal loan include quick funding and not having to put down collateral (usually).

Drawbacks include APRs as high as 36% and origination fees in some cases.

Home equity loans allow you to borrow a portion of the value of your house minus what’s still due on the mortgage. You can use the money for anything.

Benefits of consolidating debt with a home equity loan include potentially large amounts of funding and low APRs.

Drawbacks include using your house as collateral and sometimes having to wait over a month for funding.

Home equity lines of credit (HELOCs) allow you to borrow money multiple times up to a certain credit limit, based on your home’s value. Like home equity loans, you can use them to pay off debts.

Benefits of consolidating debt with a HELOC include potentially large amounts of funding, low APRs, and the ability to borrow multiple times.

Drawbacks include using your house as collateral and sometimes having to wait over a month for funding.

Balance transfer credit cards allow you to pay off multiple lenders with the card’s credit line, thereby moving the balances so that payments are due to the card’s issuer.

Benefits of consolidating debt with a balance transfer credit card include potential 0% APRs for 6 - 24 months and instant funding once you have the card.

Drawbacks include high regular APRs and often low credit limits.

Debt consolidation is a good idea if it lowers your overall interest rates and simplifies your financial situation. Debt consolidation refers to combining multiple debts into one loan or line of credit, with one monthly payment. Borrowers might consolidate their debts by paying them off with a new personal loan, home equity loan or HELOC. Or, they might transfer the balances to a credit card.… read full answer

So, whether consolidating is a good idea or not ultimately depends on the borrower’s credit history, income and other factors that determine their ability to get a new loan or credit card that will save them money, compared to the current cost of their debts. The simplicity of a single payment can be helpful, too. But it’s not always possible to consolidate fully, and you may not want to if the price tag is too high.

When Debt Consolidation Is a Good Idea

1. When it gets you lower rates: If you’re able to qualify for a new loan or line of credit with a lower APR than your current creditors are charging, consolidating the debts will reduce the overall cost of what you owe by slowing down the rate at which interest accrues. That in turn will help you pay off what you owe more quickly.
2. When you’re having trouble managing your payments: If you find yourself with too many individual debts that are hard to keep track of, and you risk missing monthly due dates as a result, consolidating can help simplify your finances.
3. When the fees aren’t excessive: If you have a credit score of 660+, you should be able to qualify for a personal loan with no origination fee. And some balance transfer credit cards for scores of 700+ have no balance transfer fees. Other loans and cards may charge fees that increase what you owe by 1% to 8%, which might make debt consolidation a bad idea.
4. When you can get enough funding: Depending on how much you owe and how high your credit score and income are, you might not qualify for a large enough loan or credit limit to accommodate all your existing debts. In that case, you might consider consolidating partially, or you might decide that opening a new account isn’t a good idea.
5. When you’re not about to make a major financial decision: In the long run, debt consolidation can help you get debt-free more quickly and raise your credit score. But it will cause short-term credit score damage from the hard inquiry required to open a loan or credit card. This could affect your approval odds or the rates you get for things like auto loans or mortgages for up to a year.

In addition, it’s not a good idea to consolidate if doing so tempts you to spend more. For example, if you consolidate multiple credit card balances and free up your credit limits on those cards, you shouldn’t take that as an invitation to rack up a lot of new charges. Instead, if you consolidate debt, you should commit to paying off your balances entirely so you don’t end up in the same situation in the future.

In conclusion, debt consolidation is a good idea when it helps you get organized and obtain better rates. It’s not a good idea when you don’t save any money or when you’re currently in the market for a car or home loan.