Which is better: a debt consolidation service or loan?

Debt consolidation is a bad idea if it does not save you any money. This happens when the interest rate on your new loan or line of credit ends up being higher than that of your existing debts, which mostly defeats the purpose of consolidation. In that case, the only benefit would be having all your debts in one place. Debt consolidation may be a bad idea in other situations too, like if you work with a misleading company or consolidate right before a major purchase.... read full answer

When Debt Consolidation Is a Bad Idea

• When the APR is higher than on your existing debts
• When your "debt consolidation" service is really debt settlement
• When you're about to buy a house or car

If your credit score is worse than when you originally took out your existing debts, it will be hard for you to find a consolidation loan with a good rate. It's a good idea to check your credit score before applying for any debt consolidation loan and to spend a few months improving your credit score if needed.

But even if your credit score is in good shape, you still have to watch out for the wrong types of companies, as well as make sure there aren't any major purchases in your near future.

Debt Settlement Services Disguised as Debt Consolidation

One major situation where debt consolidation is a bad idea is if you're using a "debt consolidation" service that actually turns out to be a debt settlement company instead. Rather than negotiating for a lower interest rate, debt settlement companies try to get your issuer to accept a lump sum and forgive the rest of your balance.

The problem is that debt settlement is a negative item that remains on your credit report for 7 years. In addition, debt settlement companies often have you avoid making payments to the lender for a while to get better negotiating power. That's very bad for your credit score, too. On top of all that, debt settlement companies can charge expensive fees.

Debt Consolidation Before a Large Purchase

Debt consolidation is a bad idea if you're about to buy a house or a car. Getting a debt consolidation loan or line of credit will damage your credit score in the short term because of the hard credit pull triggered by the application. Working with a debt consolidation company also damages your credit if you default during negotiations.

If you're about to make a major financial decision that requires a credit check, you want your credit to be as good as possible. However, at other times, debt consolidation can be a good idea. The credit score damage from applying for a debt consolidation loan is usually limited to 5 to 10 points, which you can rebound from after a few months of on-time payments.

You can predict how debt consolidation might impact your credit score by using WalletHub's free credit score simulator.

Debt consolidation is a good idea for borrowers with high-interest debts owed to multiple lenders. Whether or not debt consolidation is wise depends largely on if you can get a new loan or credit card that will save you money compared to the current cost of your debts. The simplicity of a single payment can be helpful, too.... read full answer

How Much You Can Save With Debt Consolidation

* Interest rates are from WalletHub data and total interest is calculated on a 2-year basis.

When Debt Consolidation Is a Good Idea

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.

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.

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.

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.

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.

Bottom Line

In conclusion, debt consolidation is a good idea when it helps you get organized and obtain better rates. You can click on the button below to compare the best debt consolidation loan offers on WalletHub.

Debt consolidation and debt settlement are options to help people pay off the money they owe sooner and prevent financial difficulties from escalating. Debt consolidation involves combining the existing debts into one loan or line of credit, which preferably has a lower APR. Debt settlement is when a lender agrees to forgive a portion of a person’s debt in return for receiving a lump sum of the rest of the money. Which of these two options is better for you depends on the number of debts you have, how much you owe, whether you’re up to date on payments, what your credit score is and more.... read full answer

When to Use Debt Consolidation vs Debt Settlement:

• When you have multiple debts: Debt consolidation is better because it allows you to take multiple existing debts and condense them into one monthly payment. Getting a loan and paying off your lenders is much easier than trying to negotiate with each of them.
• When you’re behind on payments: Debt settlement is better because the negative information on your credit reports from missed payments will make it harder to qualify for a debt consolidation loan or balance transfer credit card. Lenders are also more likely to settle if they are afraid of you defaulting on what you owe.
• When you want to improve your credit score: Debt consolidation is better because there is only minor damage to your credit in the short term if you apply for a loan or credit card. And in the long term, a history of timely payments to the new lender can boost your score. In contrast, debt settlement is a negative that will remain on your credit report for seven years. Plus, you’ll typically have to default on your debt in order to settle, which also leads to a lot of credit score damage.
• When you can’t afford to repay the full amount: If you’re struggling to make payments while interest keeps building up, debt settlement is better because it allows you to make a one-time lump sum of only part of what you owe, while the rest is forgiven. Debt consolidation, on the other hand, does not reduce your principal balance at all. In fact, it can even slightly increase it if you have to pay a loan origination fee or credit card balance transfer fee. You’ll have to decide whether having some debt forgiven is worth the negative consequences for your credit.
• When you have a good or excellent credit score: Debt consolidation is better because you stand a chance of qualifying for low rates and high loan amounts. You’ll have a great shot at consolidating in a way that will save you money in the long run. Debt settlement would bring that good score down. Plus, it might not even be possible to settle unless your credit score goes down a lot, since creditors usually settle with people who have defaulted.

All in all, debt consolidation is best for people who are capable of continuing to make monthly payments and who have good enough credit scores to qualify for low rates on a new loan or line of credit. Debt settlement is best for people who have already defaulted on their debt and cannot afford to pay it all off.