As a tool for getting debt back in hand, debt consolidation can be effective when properly implemented.
However, it’s important to recognize that consolidation doesn’t eradicate debts; it groups them into a single obligation at a lower interest rate, ideally with a more manageable monthly payment.
Therefore, avoiding using credit while the consolidation loan is being serviced is vital. Doing so will create a more considerable debt and make consolidation moot. With that in mind, let’s look at the best options for debt consolidation.
The Best Options for Debt Consolidation
1. Balance Transfer Credit Cards
Moving your outstanding credit card balances to one account with a lower interest rate can make sense. This is particularly true if the card to which the balances are transferred offers a zero percent introductory period. However, the linchpin to making this work in your favor is to be sure you can pay the transferred balance off in full before the introductory period ends. This will help you eradicate your debt while incurring no interest payments.
However, you could find yourself saddled with a stratospheric interest rate, interest charges going back to the date of the transfer—and many different fees besides—if there is a carryover balance when that window closes. You must also be very careful to meet all of the requirements specified in the cardholder agreement to proceed with this approach.
2. Debt Consolidation Loans
This method frees you of the concern of paying off the transferred balance before the zero percent introductory period closes. However, it also means you’ll be making interest payments from the very beginning. On the other hand, debt consolidation loan approvals come quickly, assuming you have a good credit score and a strong history of meeting your financial obligations on time.
Like balance transfer credit cards, this is an unsecured loan, so your credit score will make a massive difference in terms of whether this tactic will benefit you. You can learn more from Freedom Debt Relief’s complete guide to debt consolidation about this point. You’ll generally get a lower interest rate with no collateral requirements.
On the other hand, there might be loan origination fees, late payment fees, and some of these loans impose a prepayment penalty.
3. Home Equity Loans and Lines of Credit
You could have a ready source of untapped cash if you own a home or any other type of real property. Equity is the difference between the appraised value of a property and the outstanding loan balance against it. As the property owner, you can refinance it to its current valuation, pay off the existing loan and take the difference in cash—or as a line of credit.
This money can then be used to pay off your outstanding debt, effectively shifting it into the property. There are a number of other benefits to be realized from this strategy, chief among them is the lower interest rate you’ll get. Moreover, the interest you’ll pay on home equity loans can often be tax deductible.
However, you’ll also be exchanging unsecured debt for a loan against which you must offer the property as collateral. Should things go awry and you find yourself unable to service that loan, you could be forced to sell the property to pay off the loan. Further, you’ll encounter all of the fees that go along with getting a home loan.
4. The Smart Play
Assuming your credit history will let you qualify, the smart play here is to get the balance transfer card offering a zero percent introductory period first. Pay off as much of the transferred balance as possible at zero interest. If you determine a balance will remain, move it into a debt consolidation loan or a home equity loan (if you have equity in property) just before the introductory period ends.
This gets you the best of both approaches and ultimately makes the debt less costly to pay off. Just be careful to ensure the associated loan fees won’t mitigate any gains you might make.
Again though, the best options for debt consolidation are only as good as you are at managing your finances afterward. A stack of credit cards with zero balances after a transfer can be mighty tempting. Succumb to that enticement, and you’ll find yourself with a much larger problem than you currently have.