5 Ways to Consolidate Debt On Your Own
A Few Good, Bad, and Ugly Ways to Consolidate Debt
Debt consolidation is a way to reduce debt by combining multiple balances into a single loan with a lower overall interest rate and more manageable repayment terms.
You have a number of options for consolidating debt without the help of a debt management company. We rank them, in order of best to worst, including the benefits and drawbacks of each.
After you consolidate you will still have the same amount of debt. The benefit is that you will have rearranged your debt in a way that makes it easier to pay off.
Debt and Covid-19
Your creditors and lenders may be able to work with you if you’re having trouble making payments during COVID-19. Federal student loan payments, collections, and interest are suspended until December 31, 2020. Since this relief is automatically extended, you don’t have to contact your student loan servicer.
You also have the right to suspend mortgage payments on certain federally-backed mortgages through at least Dec. 31, 2020. Contact your lender to see if your loan qualifies and how to request a forbearance.For other credit cards and loans, you may be able to waive late fees or delay monthly payments for a few months. Contact creditors directly to find which options are available to you.
A personal loan is a type of unsecured loan that you can use for a variety of reasons, including debt consolidation. This is one of the best options if you can qualify for a low annual percentage rate (APR), relative to the overall rate on your existing debt. You don’t have to put up any collateral;, only your income and credit history are used to qualify.
If approved, your loan will have a fixed payment amount and a set repayment period, giving you a predictable payoff schedule.
Personal loans are available from traditional banks, credit unions, and online banks for amounts up to $100,000 and repayment terms up to 12 years.
When shopping for personal loans, consider the repayment period and watch out for origination fees. Spreading debt repayment over a longer period of time can lower your monthly payment, but means you pay more in interest overall. An origination fee is an upfront fee some lenders add to the balance of your loan. Look at the APR when comparing loans because it takes both the interest and any origination fee into account.
If you have poor credit, or a high debt-to-income ratio, you may have a harder time qualifying or you may not receive attractive loan terms.
Credit Card Balance Transfer
A credit card balance transfer can be a good option if you qualify, particularly when you have multiple credit card balances with different card issuers. The application process is straightforward, you don’t risk any collateral, and you’ll typically have a decision within seconds.
The drawback is that low-interest introductory APRs (often 0%) typically last no longer than 18 months. This gives you less time, relative to other consolidation options, to pay off the debt you transfer before the rate increases.
For this reason, make sure you know what the APR will be once the introductory period expires. Also, be aware that most cards assess a balance transfer fee between 3% and 5% of the amount you transfer, which could impact your ability to repay the debt by the end of the introductory period.
Avoid making purchases on your balance transfer credit card, especially if those purchases don’t qualify for a promotional rate, and you don’t pay more than the minimum due each month.
If you only make the minimum required credit card payment, that amount will be directed toward your lowest-interest debt (your balance transfer), and purchases will accrue interest at the regular APR. Building up high-interest debt defeats the purpose of debt-consolidation.
Debt Consolidation Loan
A debt consolidation loan is an unsecured loan (like a personal loan and credit card balance transfer), used exclusively to combine multiple debts into a single balance. These loans may be offered by major banks, credit unions, or online lending firms.
With debt consolidation loans, it’s important to watch out for loans with a long repayment period. Though these may have a lower monthly payment, the extended repayment time results in more interest paid over the life of the loan. Predatory loans are a concern as well. They may have temporary teaser rates that increase after a short period of time or excessive fees.
Home Equity Loan or Cash-Out Refinance
You can borrow against the equity in your home with a home equity loan or cash-out refinance. These often have low interest rates and high borrowing limits since the loan is secured by your home. Lenders consider your credit and financial history in determining whether you qualify and your rate.
You can use the cash from a home equity loan or cash-out refinance to pay off debt. But these loans may have high closing costs which could negate the value of the lower rate.
While it’s tempting, tying consumer debt to your home poses another issue as well. Since the loan is secured by your home, you risk foreclosure if you fall behind on payments. Plus, if your home falls in value, you could be upside down in the loan, owing more money than your home is worth.
Borrow From a Life Insurance Policy
If you own a permanent life insurance policy with cash value, you could potentially use it to reduce your debt. There are a few different ways to access your policy’s cash value.
First, you can take out a loan against the cash value in your policy (rates are typically low and payments aren’t required on a regular basis). Any remaining debt upon your passing will be deducted from the death benefit. Instead of taking a loan, you may be able to withdraw a portion of the money directly, without having to repay it. In either case, no qualification or credit check is required, other than that the cash value must be enough to cover the loan or withdrawal, plus ongoing policy charges.
Alternately, you could cash out your life insurance policy—terminating the policy in exchange for the net cash surrender value (ideally the entire accumulated cash value). This is usually not a good idea since you lose the death benefit for your survivors, and will probably owe taxes on the cash-out amount.
Speak to a representative at your life insurance company to understand your options, how the policy might be affected, and how to avoid a potential tax bill.
Cash-Out Auto Refinance
A cash-out auto refinance replaces your existing auto loan with a larger one based on the equity you have in your vehicle. After applying with a bank, credit union, or online lender, you’ll receive a new loan, with new terms, and a lump sum of cash you can use to consolidate your debts.
This option ranks low on our list because vehicles depreciate quickly. In other words, with a cash-out auto refinance, you may soon have negative equity in your vehicle. This can be a problem should you want to sell the car or if you get in an accident. For instance, if your car is declared a total loss, your insurance company will only cover the actual cash value of the vehicle, potentially leaving you with a loan balance to take care of.
Depending on how much equity your vehicle has, you may not be able to make a significant dent in your debt balance. If you can’t keep up with payments, you risk having your vehicle repossessed.
Borrow From Retirement
Many 401(k) plans give you the option to borrow up to 50% of the available funds, without going through a traditional loan application and credit check.
You have five years to repay the loan plus interest. Otherwise, any unpaid amount is considered an early withdrawal and will be subject to a penalty and income tax. If you leave your job, you’ll have to repay the loan by the due date of your next tax return or face early withdrawal penalties.
This option should be considered only as a last resort. Borrowing from retirement poses a huge risk to your retirement savings. Even if you make contributions while repaying the loan, you give up years of earning interest on the amount you borrow, which can severely impact your future retirement.
A Word of Warning
If you have a steady income and good credit, your debt consolidation options are many. Similarly, owning assets such as a home, vehicle, life insurance policy, or retirement plan gives you the means to restructure debt on your own. But if you’re struggling, seek help from a professional credit counseling agency or debt consolidation company to help you sort through your options and chart the best course of action.
You may need help from a professional agency if you can’t qualify for traditional options because you have poor credit or few assets. Bankruptcy can be a good alternative if your debt is too high to pay back in five years.
Federal Student Aid. "Coronavirus and Forbearance Info for Students, Borrowers, and Parents." Accessed Nov. 13, 2020.
Consumer Financial Protection Bureau. "Learn About Mortgage Relief Options and Protections." Accessed Nov. 13, 2020.
Federal Trade Commission. "Credit Card Accountability Responsibility and Disclosure Act of 2009." 123 STAT. 1741. Accessed Nov. 13, 2020.
Consumer Financial Protection Bureau. "What Do I Need to Know if I’m Thinking About Consolidating My Credit Card Debt?" Accessed Nov. 13, 2020.
Pacific Life. "Four Ways to Access the Value of a Life Insurance Policy." Accessed Nov. 13, 2020.
IRS. "Retirement Topics - Plan Loans." Accessed Nov. 13, 2020.