With the U.S. economy officially in a recession and historic unemployment numbers, many people are feeling the squeeze. According to a recent NextAdvisor survey, more than half of all Americans have felt anxiety over their personal finances in recent months, with debt being a significant contributor.
While debt is an everyday part of life for many, it can snowball into big problems when you fall behind on payments. But there are things you can do before you fall too behind on your debt. Debt consolidation may be a way to lower the interest rate or monthly payments of your current obligations. But this isn’t a solution for everyone, and with so many different ways to consolidate debt, you should be thoughtful about what might make sense for you.
What is Debt Consolidation?
Debt consolidation is the process of combining all of your debts into a single payment, often with a loan or balance transfer credit card.
“Typically with debt consolidation, you’re also looking to lower your interest rate. So it would be [to] save money and save hassle,” says Ted Rossman, a credit card analyst with Creditcards. When done well, debt consolidation can help you get out of debt faster and save, or rebuild, your credit.
Debt consolidation shouldn’t be confused with debt settlement, which all of the experts we talked to said to avoid if possible. “When you settle for less than you owe, it’s a bad thing for your credit score,” Rossman says. “And also, a lot of those companies will try this tactic where they tell you to stop paying for a while.” Debt-settlement companies will use the fact that you aren’t paying back your debt as leverage to negotiate a smaller payback, says Rossman. However, there is no guarantee this strategy will work, and even if it does, an account that is settled for less than you owe will negatively impact your credit report for seven years.
How to Consolidate Debt
There are six different ways to consolidate debt, but the financial tools you can use fall into two main categories: secured and unsecured.
A secured loan is backed by something of value you own, like your home or car. An unsecured debt has no underlying asset or collateral attached to it. With secured debt, if you default, the lender can take your home or other physical property. For that reason, unsecured debt, like that of a balance transfer credit card, is a preferable and safer way to consolidate.
Secured loans are less risky for a lender than unsecured loans, so they can have better interest rates and terms. But that doesn’t mean a secured loan is always the best option. A home equity line of credit (HELOC) may have a better interest find more information rate than your current debt – but if you can’t pay, your house is on the line.
Choosing the right debt consolidation strategy depends a lot on your financial situation. The catch-22 is that to qualify for the best interest rates, you’ll need to have a high credit rating. And those in dire financial situations may not even be able to qualify for some of the better debt consolidation options, like 0% APR credit cards or low interest personal loans.
Lenders are worried about the future of the economy, so they are implementing higher standards for balance transfer credit cards, home equity lines, and personal loans, says Rossman. “Unfortunately, it’s a tough time right now for debt consolidation because a lot of the normal avenues have either dried up or they’re just harder to qualify for,” Rossman says.