Dealing with debts can be a frustrating, emotionally burdensome experience. Whether you have high credit on your credit card, ongoing medical debts or a mortgage that is crippling, your financial obligations can disrupt your ability to lead a balanced life. If you think you cannot pay off your debts on your own, you might consider an option that has eased hundreds of thousands of other Americans: a debt consolidation loan, also known as a refinancing loan.
These loans can be a great help to borrowers who owe a lot of money – but they do entail risks. It is important to understand the disadvantages and consider all your alternatives before deciding whether a debt consolidation loan is right for you.
What is a debt consolidation loan?
A debt consolidation loan pays off your existing debts and combines those balances into a single monthly invoice with a new interest rate. The goal is to reduce the number of invoices that you have to keep and to lower the total interest rate for your outstanding obligations.
These loans can be unsecured, meaning that they are only guaranteed by your promise to pay back or secured, meaning that they are linked to a physical asset – usually your house, but sometimes a retirement account, life insurance policy, car or other valuable personnel. possession. Unsecured loans may only apply to unsecured debts, such as credit cards and medical bills. The proceeds from secured loans can be applied to a wider range of obligations, including mortgages and car loans. Secured debt consolidation loans generally have lower interest rates than unsecured loans.
Who offers debt consolidation loans?
Different types of financial institutions offer debt consolidation loans:
- Specialized lenders . Many lenders are specialized lenders (also known as financial companies) who do not accept deposits, such as traditional banks and credit unions. They can pay your old creditors immediately and then send you a monthly bill for the balance, or send you a check or direct deposit for the full amount. Financing loans from companies generally start at the prime rate (currently 3, 25%) plus 5%. Their creditworthiness requirements may be less strict than those of traditional banks; however, their rates may be higher for borrowers with average credit. Loan limits vary per company, but $ 25,000 is normal.
- Benches . Community and national banks, including Wells Fargo, PNC and the US bank, make safe and unsecured debt consolidation loans to borrowers with good credit. PNC advertises a current rate of 8, 79% for borrowers with a strong credit, and US Bank offers 13, 25% for those with the lowest acceptable credit score. It is also difficult to find bank loans at a lower than prime plus 5%. These products usually require full refund within 60 months. Loan limits can vary greatly, from $ 25,000 at the US bank to $ 100,000 at PNC, although higher amounts require excellent credit.
- Credit Unions . Credit unions also offer debt consolidation loans, with terms of 12 to 60 months, often with discounted or fixed rates for members. For example, members of the Western Federal Credit Union pay 0, 25% less for loans than non-members. ABE Federal Credit Union has a fixed rate of 9, 49%, regardless of the credit score, for loans shorter than 36 months. Loan limits reach $ 50,000 at Western, but you must have excellent credit to qualify.
- Payday Lenders . Unlike other types of debt consolidation loans, an unsecured payday loan does not require a credit check. Instead of paying off your individual debts directly, pay givers give you cash and you can arrange them yourself. Since these loans have a high interest rate (15% and higher, or the prime rate plus 12%) and repayment periods sometimes have a few weeks, they are generally not recommended for large debt Valmontast. Your borrowing power is also limited by your monthly income.
- Peer-to-peer lending services . Peer-to-peer (P2P) lending services, such as Prosper and Lending Club, facilitate unsecured loans between individuals and take a reduction in the interest charged. The rates depend on your credit history and can range from 6% (prime plus 3%) for borrowers with excellent credit, to more than 30% for those on the other side of the spectrum. The loan conditions can vary from 36 to 60 months, with larger amounts receiving the longest conditions. Borrowing limits at Prosper and Lending Club top of $ 35,000 for those with excellent credit. P2P debt consolidation loans are not available in certain states, including North Dakota, Maine and Iowa.
- PersooValmont-rich credit lines from a bank or credit association . Many banks and credit unions also offer unsecured lines of credit to qualified borrowers. Rates and limits are similar to debt consolidation loans from banks and credit unions, but credit lines generally do not have to be repaid within 60 months.
An alternative: borrow yourself
If you take out a debt consolidation loan, you must borrow from a bank or other financial institution. However, some struggling borrowers choose to keep things closer to home and borrow from themselves with one of these options:
- 401,000 loans . Depending on the details of your 401K plan, you may be able to borrow from it. You can borrow at least $ 50,000 or 50% of the unconditional balance of your plan (the amount that your employer cannot take back when you leave your job). If your acquired balance is between $ 10,000 and $ 20,000, you can take $ 10,000. Just like bank loans, 401k loans have a maximum term of 60 months. No credit check is required. You pay interest, usually at a rate close to prime, for yourself. A major disadvantage of a 401K loan is that if you leave your job for whatever reason, you must pay the full balance within 60 days.
- Borrowing a present value life insurance policy . You may also be able to borrow from your life insurance policy at cash value. Contact your specific insurer to understand how a policy loan influences your death benefit. These loans generally vary between 2% and 6% plus prime.
Is a debt consolidation loan suitable for you?
Both secured and unsecured debt consolidation loans have common benefits: Simplify your monthly debt payment schedule, lower your interest rates compared to your old credit cards and help you rebuild your credit if you can make your payments on time. They also share a common disadvantage: while taking out a debt consolidation loan does not automatically harm your credit score, it can simultaneously cancel all your credit cards after using a loan to pay off their balance – a common mistake – reduce it to 50 points per card, depending on your previous credit history.
Before making decisions, also consider these category-specific advantages and disadvantages:
Unsecured loan Advantage
- No collateral Requirements . Unsecured debt consolidation loans do not require that you hold assets as collateral, so that you will not lose any physical assets if you cannot repay.
Unsecured loan disadvantages
- Higher interest rates . Because they are not supported by collateral, unsecured debt consolidation loans are much more risky for lenders. As such, they usually come with higher interest rates. If you have an excellent credit score (780+), the difference can be manageable compared to what you would pay with a secured loan. With a lower credit score, your loan can be much more expensive than a secured loan, although it could still be better than the card it replaces. If you can provide the necessary collateral, you can use a secured loan to increase the difference between your old credit card interest and your debt consolidation loan. Note that the rates on P2P loans can vary greatly, ranging from an APR of 6.73% for first-class Prosper borrowers to nearly 36% for first-timers with a lower rating – more than the penalty interest on many credit cards.
- Strict credit requirements . If your credit score is lower than 650, it may be difficult to qualify for an unsecured loan from a bank or a credit union. While P2P lenders and finance companies provide loans to borrowers with lower credit scores, their rates are likely to be much higher than on a secured loan and possibly even higher than your old credit card. Your credit score also affects the size of your loan, so while you are eligible for a $ 30,000 or $ 50,000 loan if you have excellent credit (780+), you are eligible for much less without that benefit .
Secured Loan Advantages
- Lower interest rates . Although the exact rate depends on your credit score, loan size and location, your secured debt consolidation loan is probably cheaper than an unsecured loan. For example, the APRs for a home credit line of $ 30,000 (HELOC) amount to 3, 5% to 6% for borrowers with an average credit score of 700.
- Less strict qualification requirements . Because your lender can take back your collateral if you do not meet your loan, you do not need a strong credit score. Some lenders accept a score of only 500. However, the amount for which you are eligible is limited by the value of your collateral.
- Better conditions for reimbursement . Some secured loans have smoother repayment requirements – with equity loan, balances up to 25 years can sometimes be outstanding. This can further reduce your monthly obligations and increase the chance that you can pay your bills.
- Higher borrowing limits . Depending on the value of your collateral, you can be approved for a larger loan. While lenders demand excellent credit for unsecured loans of $ 30,000 or more, you can borrow 85% of your equity for a guaranteed loan.
Secured Loan Disadvantage
- Potential loss of assets . When you hold an asset as collateral – whether this is your house, an insurance policy or part of your pension plan – you agree to forfeit it if you do not honor your loan. An unexpected loss of job, medical bill or death in the family can jeopardize your plans.
Since debt consolidation loans are issued by a large number of financial institutions, it is worth investigating lenders before making a decision. Use your local Better Business Bureau or consumer protection office for research and stay away from organizations with a history of previous complaints or legal action.
If you are considering a debt consolidation loan, research these alternatives before you make a final decision:
- Credit Counseling . Credit advisory organizations, which often receive financing from banks and other financial institutions, offer consumers free or inexpensive financial education services. Many also offer debt management plans. These are voluntary arrangements between borrowers and creditors that can help to lower interest rates, lift fines and consolidate funds in one monthly invoice. If you have to cancel credit cards as part of your debt management plan, your credit score may drop – how much depends on how many other credit cards you have and your total debt / credit ratio. A record of each cancellation can remain on your credit report for up to seven years.
- Debt settlement programs . As with a debt management plan, a debt settlement program is mediated by an intermediary organization that negotiates discount bids with your creditors. The process can take up to four years, during which you make monthly deposits into a blocked account in preparation for a lump sum payment of all participating debts. As with debt management, participation in debt agreements is voluntary, and the process can lower your credit score anywhere by 50 to 150 points – the hit is greater if you had a good credit before. For each settled debt, the record appears on your credit report for a maximum of seven years.
- Bankruptcy reorganization or liquidation . There are two main types of consumer bankruptcies, both under the supervision of a court: Chapter 13, or reorganization, and Chapter 7, or liquidation. The former creates a new payment plan for your unsecured debts, while the latter wipes out many of your unsecured debts and may oblige you to sell assets to repay your secured creditors. Your creditors are required by law to participate, although not all debts can be declared bankrupt. Bankruptcy can seriously affect your credit score and it takes you seven (chapter 13) to ten (chapter 7) years to hand in your record. The impact varies depending on your current credit score and recent history, but it can vary from less than 100 points to more than 200 points. As with debt settlement, if you had good credit before, the blow of a bankruptcy could be even worse.
- Credit card balance transfers . If you are particularly struggling with credit card debt, transferring your high interest rate to a lower interest rate card can make your situation more manageable. Many credit card companies offer iValmonthising balance transfer rates – often as low as 0% – for new customers. These rates can vary from 6 to 24 months, after which they are reset to the normal rate of the card. You are also limited by the credit limit for which you have been approved.
Debt consolidation loans can help you pay off high-yield credit card bills, medical debts and other obligations and put the balances together in one monthly payment, usually with a lower interest rate. When used judiciously, they can reduce the total cost of your debt and help you make a sustainable budget.
However, debt consolidation loans have many potential pitfalls, including the risk of capital loss on secured loans. Do not take a debt consolidation loan without weighing up other options, such as balance transfers on credit cards and credit advice. And, of course, talk to a financial adviser if you think you need further guidance.