Consolidate Loans

If you've watched TV or opened your mail lately, you know that there are plenty of companies eager to help you consolidate your loans to "cut your payments in half," "lower your interest rates," and "help you get out of debt fast." Indeed, consolidating your high-interest loans and credit card debt into a single loan with a lower interest rate and more manageable payments makes perfect sense. Unfortunately it doesn't always work out that way. Many people who consolidate loans end up paying more than they would have otherwise. In the case of home-equity loans, in fact, an alarming number of borrowers end up losing their homes. Many so-called "consolidation" programs can prove not to consolidate debt at all. Thus, debt consolidation has rightfully begun to earn a bad reputation. It's still possible, however, to benefit from consolidation if you explore your options and proceed with caution. This article will help you do that.

Steps

  1. Get your credit report and FICO score. The terms of any loan you get will be based largely on your credit score, so you should find out what it is. If your score is reasonably high, you may qualify for an attractive interest rate on a consolidation loan, especially if your credit has improved since you first acquired the original loans.
    • Go over your entire credit report carefully to make sure it's accurate. Inaccuracies can hurt your score and keep you from getting the rate your deserve.
  2. Consider all your options. Before you jump into a debt-consolidation loan, think about your other options:
    • If you just want to save money but you're not in dire straits, simply pay off your debts fast by prioritizing them. Pay as much as you can each month on your highest-rate loan while making minimum payments on the others. Pay off that first loan, and then attack the loan with the next-highest rate. Keep doing this until all the loans are paid off. This method lowers your monthly finance charges as quickly as possible.
    • Call your credit card company. If you have relatively good credit, you may be able simply to talk to the credit card company and negotiate a lower interest rate. If they won't give you a lower rate, you may be able to transfer your balance to a credit card with a lower long-term rate or a no-interest, introductory rate. In the latter case make sure you know what your rate will be after the introductory period.
    • Contact a credit counseling agency. A reputable credit-counseling agency can provide you with free or low-cost advice on how to manage your debt, and they can help you prepare a budget to get your finances under control. Credit counseling, however, does not necessarily mean entering into a debt-management program, and you should be wary of any organization that tries to push you into such a program. In general, be careful when choosing a credit-counseling agency. Even some registered non-profit agencies have been known to charge high fees.
    • Sell your car. If you can't afford your car payments, sell the car to pay off the loan, and buy something cheaper. If the car gets repossessed, it will end up costing you even more money.
    • Talk to your mortgage lender. Reputable lenders will usually work with you if you have some temporary trouble paying. Call them as soon as you know you'll have trouble, and they may temporarily suspend your payment or accept reduced payments. You might also be able to extend your repayment period, thereby reducing your monthly payments (but increasing the total mount you'll wind up paying). You may be given the option of paying interest only (not the principal), reducing your payments for a time. Inquire about any additional fees or penalties with any of these arrangements. Consider refinancing your home if you can get a better interest rate on your mortgage loan.
    • Borrow from your life insurance. Whole-life policies usually allow you to borrow against the cash value of the policy. This amounts to an easy, low-interest loan that can get you quick cash to pay off debts. Be sure to check on the tax implications of such an arrangement, and understand that if you don't repay the loan, it will be subtracted from the amount your beneficiary ultimately receives.
  3. Understand the difference between a consolidation loan, a debt-management program, and debt negotiation. Companies that claim to be able to help you lower your payments or get out of debt quickly may appear to be offering consolidation loans––they may even have the word "consolidation" in their names––when in fact they use methods such as debt management, settlement, or even bankruptcy. There are major differences between these options:
    • A consolidation loan is simply a loan that pays off other loans. Once you consolidate loans, you owe that money to the new lender, not to the original creditor. A consolidation loan can lower your monthly payments by either reducing your interest rate or extending the repayment period while paying off other creditors completely. Know that a consolidation loan may temporarily blemish your credit record but generally not to the extent that debt-management programs or debt negotiations will.
    • Make a Debt Management Program Work for You may also reduce your payments, but they work differently. A debt-management agency acts as a middleman between you and your creditors and tries to negotiate a reduction in the interest rates or fees on your loans. You then pay an agreed amount to the debt-management or credit-counseling agency, and they disburse the payment (usually minus a fee) to your creditors. Participation in a debt-management plan usually shows up on your credit report and may adversely affect your credit rating.
    • Debt negotiation is the act of settling a debt for less than what you owe. You pay a part of what you owe to a creditor, and the creditor writes off the rest of the debt. Credit card companies often offer lump-sum settlements as a way to recoup part of their losses. While you end up owing less, a settlement will bruise your credit badly. Worse still, third-party companies that offer debt negotiation have been known to disguise their practices as consolidation, and these companies frequently charge exorbitant fees while simply passing along payments to your original creditors, sometimes failing to re-negotiate your repayment terms.
  4. Aim to pay off your debt quickly. One of the most attractive features of consolidation loans is the potential for lower monthly payments. However, if the reduced payments are just the result of spreading your repayment over a longer period of time, you'll wind up paying more in interest than you would have otherwise. Figure out your budget, and set your monthly payment as high as you safely can. You'll pay less interest and get out of debt quicker.
  5. Get the right loan for you. Debt-consolidation loans can be secured (backed by collateral) or unsecured (often known as "personal loans").
    • Secured loans, such as second mortgages, secured lines of credit, or home-equity loans, will typically have lower interest rates than unsecured loans, because if the borrower defaults on the loan, the lender can recoup the money by selling the underlying asset. Interest on a home-equity loan may be tax-deductible, which can save you even more money. Keep in mind, however, that if you fall behind on a home-equity loan, the lender can foreclose on your house.
      • Carefully consider the risk before opting for a secured loan. Such loans may include hidden fees such as "points" (a point equals one percent of the amount borrowed), that may drive up the cost of your loan.
    • Unsecured loans are a safer option, because you don't have to risk your house or other assets. If you have good credit, you should be able to get a decent rate (certainly compared to credit cards) on an unsecured personal loan. Depending on your situation, however, especially if you have poor credit, you may find that only a secured loan will get you a lower rate than what you're currently paying.
  6. Shop around. Get quotes from several different lenders, and compare the terms and interest rates carefully. Your own bank or credit union is often your best bet, particularly for personal loans, but it's a good idea to shop around.
    • Get quotes in writing so you can compare lenders side-by-side. There are also websites that allow you to compare lenders.
    • Make sure you understand all the fees and conditions associated with a loan. If you want to get a solid loan offer, you'll need to apply formally, as the final interest and fees may vary considerably from those quoted. Get as reliable a quote as possible by providing accurate personal information.
  7. Compare the total cost of consolidation to your current situation and to other consolidation loans. Don't look only at the monthly payment. That's how consolidation companies lure you in. Even with the lower payment you may end up paying more under the consolidation. Consider the interest, initial and recurring fees, closing costs and points (for secured loans), and any tax implications over the life of the loan. Choose the best option by comparing the proposed loan's total payoff amount to that of your current loans. If you can realize substantial savings on the total cost of the loan, consolidation is probably a good option.
  8. Read your loan contract carefully. Read every word, and then read every word again. Ask any questions you may have, and make sure you understand the answers, no matter how many times you have to ask. If in doubt, get a lawyer or another knowledgeable, independent source to take a look at the documents for you. Something that seems inconsequential in a contract can end up costing your thousands of dollars or even your home, so do your due diligence.
  9. Reject credit insurance. Some lenders will attempt to pressure you into buying credit insurance, either by extolling its virtues, by implying that your application will be rejected without it, or by simply sneaking it past you. If a lender does either of the latter two, get out of there and file a complaint with the appropriate authorities (in the U.S., the Federal Trade Commission handles complaints, as do many state attorneys general). Credit insurance can add a significant cost to the loan, and it generally offers you very little protection. The lender may make the cost seem small by telling you the monthly price, but don't be fooled.
  10. Finalize the loan. If your loan hasn't already been approved, complete the full application process. This should be straightforward, but it can take some time and footwork. If your loan rate is different from that which you were quoted, find out why, and then check with your next-best option. Don't get taken by bait-and-switch tactics.
  11. Control your spending. If you're looking to consolidate because you've gotten in debt over your head, there's no time like the present to take a good look at your budget and balance it so that you don't continue to dig yourself in.



Tips

  • When deciding on a monthly payment amount, be sure to give yourself a little safety cushion, especially for a secured loan. While you want to pay off the debt as quickly as possible, you don't want to get into a situation where you can't afford the payment if something unexpected comes up.
  • If you're not familiar with a lender, do some research. Check to see if there have been any complaints filed against it with the Better Business Bureau or the Federal Trade Commission. Search for the lender on the Internet to see if you can find any interesting information. Whoever your lender is, make sure you understand the terms of your loan fully.
  • There are online calculators you can use to compare the cost of your current debts with the cost of a consolidation loan. Be careful with them. Calculators on some lender sites assume a low rate for the consolidation loan and high rates for your other loans. This may not reflect the real numbers in your case, and you won't get an accurate comparison if you can't enter the correct interest rates. Be sure to add in any fees, too.
  • The lender should divulge to you the total cost of the loan. If they don't, it's easy to calculate. Simply multiply the monthly payment by the number of months in the loan, and then add any fees or points. It's a good idea to do this even if the lender does quote you a total cost figure.

Warnings

  • The worse your credit, the higher the interest rate you can expect to pay. It also seems to be the case that the direr your situation, the more companies will try to take advantage of you. Be realistic, but explore all your options. Above all, make sure you completely understand the terms and conditions of your loan, and watch out for excessive fees.
  • Treat debt consolidation as a way to pay off your debts, not as a way to free up extra spending money. If you don't control your spending, you'll just go deeper into debt.
  • Debt may be the symptom of a larger problem. Unless you solve the underlying problem, you'll soon be back in debt, and you'll have the consolidation loan on top of all the others. Get yourself on a spending plan (a budget), and stick to it for several months before consolidating your debts to prove to yourself that this is going to be a viable route for you.

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Sources and Citations

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