Debt Consolidation Favorite Asked Questions (FAQs)

  1. Is debt consolidation bad?

It can be if you don’t change the habits that caused your debt. If you continue to overspend with credit cards or take out more loans you can’t afford, rolling them into a debt consolidation loan will not help.

  1. How do I consolidate debt and pay it off?

The first step is to list the amount owed on your monthly unsecured bills. Add the bills and determine how much you can afford to pay each month on them. Your goal should be to eliminate debt in a 3-to-5 year window. Reach out to a lender and ask what their payment terms, interest rate, monthly payment and number of years to pay it off, would be for a debt consolidation loan. Compare the two costs and make a choice you are comfortable with.

  1. What type of loans can I consolidate?

Any unsecured debt, which includes credit cards, medical bills or student loans.

  1. What are the best loans for debt consolidation?

Depending on the amount owed, the best consolidation loans are credit card balance transfers, personal loans, home equity loans and an unsecured debt consolidation loan. A good-to-excellent credit score is needed for credit card balance transfers. Peer-to-peer online lending has become a good outlet for personal loans. A home equity loan is a secured loan, which means better interest rates, but you are in danger of losing your home if you miss payments. An unsecured debt consolidation loan means not risking assets, but you will pay a higher interest rate and possibly receive a shorter repayment period.

  1. Who qualifies for debt consolidation loans?

Anyone with a good credit score could qualify for a debt consolidation loan. If you do not have a good credit score, the interest rate charged and fees associated with the loan, could make it cost more than paying off the debt on your own.

  1. Can I consolidate my debt without a loan?

Yes. A debt management program (DMP) is designed to eliminate debt without the consumer taking on a loan. A credit counseling agency takes a look at your monthly income to help you build an affordable budget. Counselors work with creditors to lower interest rates and possibly eliminate some fees. The two sides agree on a payment plan that fits your budget. DMPs normally take 3-5 years, but by the end, you eliminate debt without taking on another loan.

  1. How does debt consolidation affect your credit?

Generally speaking, debt consolidation has a positive impact on your credit score as long as you make consistent on-time payments. The two major factors involved in determining its effect on your credit score are

  1. Which debt consolidation program you use; and
  2. how committed are you to making on-time payments?

If you choose a debt management program, for example, your credit score will go down for a short period of time because you are asked to stop using credit cards. However, if you make on-time payments in a DMP, your score will recover, and probably improve, in six months.

If you choose a debt consolidation loan, your poor payment history already has dinged your credit score, but paying off all those debts with a new loan, should improve your score almost immediately. Again, making on-time payments on the loan will continue to improve your score over time.

Debt settlement is a no-win choice from the credit score standpoint. You score will suffer immediately because debt settlement companies want you to send payments to them and not to your creditors. That’s a big problem. So is the fact that a debt settlement stays on your credit report as a negative consequence for seven years.

  1. Are debt consolidation loans taxable?

The IRS does not tax a debt consolidation loan. More importantly, it does not allow you to deduct interest on a debt consolidation loan unless you put up collateral, such as a house or car.

  1. How much does it cost to consolidate your debt?

The cost of debt consolidation depends on which method you choose, but each one of them includes either a one-time or monthly fee. You will pay interest on a debt consolidation loans and taxes on debt settlement. Generally speaking, the fees are not overwhelming, but should be considered as part of the overall cost of consolidating debt.

  1. Which debt consolidation plan is right for me?

There are so many choices available that it is impossible to single out one. The Federal Trade Commission recommends contacting a nonprofit credit counseling agency to determine which debt consolidation plan best suits your needs. You may ask yourself, what does a credit counselor do? Credit counselors help consumers set up a budget and offer options to eliminate debt. Credit counselors are typically available for over-the-phone or in-person interviews, and their service is usually free.

  1. Does debt consolidation work on a limited income?

Debt consolidation loans are difficult for people on a limited income. You will need a good credit score and sufficient monthly income to convince a lender that you can afford payments on the loan. A better choice might be to consult a nonprofit credit counselor and see if you are better served with a debt management program.

  1. Do lenders perceive debt consolidation negatively?

Most lenders see debt consolidation as a way to pay off obligations. The alternative is bankruptcy, in which case the unsecured debts go unpaid and the secured debts (home or auto) have to be foreclosed or repossessed. Lenders don’t like either of those choices. You may see some negative impact early in a debt consolidation program, but if you make steady, on-time payments, your credit history, credit score and appeal to lenders will all increase over time.

  1. What is debt consolidation refinancing?

It means including other debts in a refinancing of your home. If you have $10,000 in credit card debt and owe $90,000 on your home, you would refinance the home for $100,000 and use $10,000 of that money to do a one-time payoff of your credit card debt. This is only a valuable if you have equity in your home (market value is higher than mortgage balance) and you receive a lower interest rate and monthly payment on your new mortgage.

  1. Who can help me consolidate my debt?

Be careful. Debt consolidation companies are not all the same. Look for a company with good reviews, a high grade with the Better Business Bureau and that is transparent about services and fees.

  1. Can I consolidate medical debt?

Yes, you can consolidate medical debt. However, there may be little benefit in doing so, as medical debt is typically low to no interest debt. Medical debt consolidation may provide no savings based on a lower interest rate.

  1. How do I consolidate my student loans?

If you’re having difficulty making payments, you may want to consider consolidating your student loans under one of the many available repayment programs available on Federal student loans. Interest rates will be the same, but you can lower your monthly payment by electing a longer term or choosing an income-based repayment program.

  1. Do It Yourself Credit Card Consolidation?

The Do-It-Yourself debt consolidation method is time consuming and fraught with frustration, but it can be done. Call the card companies and try to negotiate lower rates and maybe even a break on your balance. Be aggressive, but be aware that the success rate is low.

The alternative DIY method is obvious: Get rid of your credit cards. Lock them in a drawer and hide the key. Pay for everything in cash. Set aside a portion of your income every month to pay down balances one card at a time, until they are all paid off.