The 5 Best Ways to Consolidate Debt

Being in debt drains your wallet and your energy as you struggle to keep up with your payments month after month. When a significant part of what you pay goes straight to the interest, it often feels like you’re not making any progress at all. Moving to consolidate your debt can be a good option for people who want to lower their interest rates and simplify their monthly payments.

When you consolidate debt you’re essentially combining several debts and paying them off at a new interest rate. Your new loan pays off your old loans, and you pay interest on your new loan.

There are several different ways to consolidate your debt but some choices may be better than others, depending on your situation. Enlisting the services of a nonprofit debt consolidation company and/or credit counseling organization can help you assess the state of your debts. Seeking out nonprofit debt relief won’t leave you owing exorbitant sums for credit counseling, and it will leave you with a solid understanding of how to tackle your debts. If you’re wondering which route to take from there, here’s a look at how each option measures up.

Balance Transfer

If most or all of what you owe is credit card debt, using a balance transfer to combine the balances can potentially save you hundreds of dollars in interest. Many credit card companies offer 0% promotions to attract new customers, which means you pay no interest on your balance for a set period of time, typically anywhere from six to 18 months.

While a balance transfer can certainly save you money, there are a few catches. Generally, you’ll need to have good credit to complete a balance transfer. You’ll also likely have to pay a fee to transfer your balances, which may be anywhere from 3% to 5% of the total amount you’re transferring.

Most importantly, you’ll be on the hook for all the accrued interest if you don’t pay off the balance by the time the promotion ends. If that happens, you really haven’t saved any money at all. In fact, you’ve only added to your debt if you had to pay a substantial fee to complete the initial transfer.

Personal Loan or Line of Credit

Taking out a personal loan or opening a personal line of credit from your bank or credit union is another way to refinance your debt to a lower interest rate. Compared to a balance transfer, you typically have a longer repayment period with a personal loan and your monthly payments are fixed so it can be easier to budget.

You may not be able to score a 0% deal with a personal loan but it’s often easier to get the loan paid off without having to worry about accrued interest being tacked on at the end. On the other hand, getting approved for a personal loan or line of credit can be tricky if your credit is less than perfect. Checking your credit score before you start shopping around for a lender can give you an idea of whether this option is a possibility. Unfortunately, credit consolidation loans for those with bad credit are either nonexistent or have interest rates so high that they’re a big risk.

Home Equity Loan

Tapping your home equity to pay off debt definitely has some pros and cons. The interest rate you’d pay on a home equity loan or line of credit would likely be much lower than what you’re currently paying. Depending on how much value you’ve built up in the home, you may also be able to borrow significantly more than what you could with a personal loan.

The downside of a home equity loan is that you’re essentially trading unsecured debt for secured debt. If you fall behind on an unsecured debt, like a credit card bill, your creditors could take you to court and try to garnish your bank account or your wages to get you to pay. If you find yourself unable to make the payments on a home equity loan, you’re putting the house itself at risk if your lender decides to foreclose.

Debt Management Plan

Debt management plans are a tool typically offered by both for-profit and nonprofit credit counseling agencies. The credit counselor contacts each of your creditors on your behalf and proposes a monthly payment and interest rate that best fits your financial situation. Assuming all your creditors get on board, you make one monthly payment to the credit counseling agency, which then distributes the money to the debts on your plan.

If you’re feeling completely overwhelmed by your debt, enrolling in a debt management plan puts you on a defined path to paying it off. You’ll pay less in interest and you’ll only have the one payment to keep up with each month. However, many debt management companies do charge a fee for their services so you’ll need to weigh this cost against any reduction in interest to see how much you’re really saving. You’re better off seeking help from non-profit debt consolidation companies. Do your homework before you commit to a debt management plan will last months if not years.

If you have bad credit you should know that getting on a debt management plan isn’t an immediate ticket to a higher credit score. In fact, participating in a formal debt management program can temporarily lower your credit if your credit counselor negotiates lower payments for you that your creditors then report to the credit bureaus, or if paying off old debt reactivates those debts on your credit report. In the long run, though, it’s best to get on a plan that will lead you to a debt-free life.

Retirement Loan

Borrowing from your retirement account may be a last-resort option if you can’t qualify for any other type of debt consolidation. If you have a 401(k) or a similar employer-sponsored plan, you can usually get a loan with a relatively low interest rate and you’re essentially paying the interest back to yourself.

Taking out a retirement loan can help you get out of debt faster and save on interest. But you shouldn’t overlook the fact that you’re shrinking your nest egg in the process. Even though you’re putting the money back into your own account, you’re still missing out on any growth that would have accumulated if you hadn’t taken it out in the first place.

Not to mention if you leave your job before the loan is paid off, your employer will expect you to pay the remaining balance in full. If you can’t repay the loan, the money is treated as a distribution which means you may have to pay income taxes on it, along with a 10% early withdrawal penalty if you’re under age 59 1/2.

Bottom Line

Each of these methods to consolidate debt has its pros and cons and you need to weigh them carefully before making a final decision. What may seem like a great deal may be too good to be true if it ends up costing you more money in the long run.

Rebecca Lake has been writing about the nuts and bolts of personal finance for nearly a decade. She is an expert in investing, retirement and home buying topics. Her work has been featured on The Huffington Post, Business Insider, CBS News, U.S. News & World Report and Investopedia. As a homeschooling mom of two, she’s always looking for ways to make the most of every dollar.

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