A debt consolidation loan is a personal loan that combines multiple debts into a single loan with one payment. Simplifying your payments can make it more manageable to pay off your debt, but it may not fix the underlying reasons for the debt in the first place and isn't an option for everyone.
Alternatives to debt consolidation loans may include changing your spending habits, tapping into your home equity or adjusting your budget. If you're having difficulty managing your debt but can't qualify for a debt consolidation loan that makes sense, look over these six alternate ways to reduce and reorganize your outstanding bills so you can breathe.
Why a Debt Consolidation Loan Isn't for Everyone
Paying off high-interest debts, such as credit cards, with a debt consolidation loan can be a good strategy for many people. It combines multiple payments and due dates into one monthly payment and may lower your interest rate and how much you pay each month. But If your credit is poor, it can be challenging to qualify for the most competitive interest rates and terms.
Many debt consolidation loans also come with origination fees and other fees that can add to the cost of your debt. Additionally, you may not be able to pay off all your debts with a debt consolidation loan, which means you'll still be juggling payments.
The most compelling reason why a debt consolidation loan may not be for you is that it doesn't solve the underlying habits that may have led to the debt in the first place. Fortunately, there are alternatives to a debt consolidation loan that can help you stay on top of your bills and begin paying down your debt.
1. Balance Transfer Credit Card
A balance transfer credit card can help you pay off debt with a promotional 0% APR usually lasting 12 to 21 months. That means you can transfer high-interest debt to the card and pay it off without paying interest during the introductory period. However, the best offers with the longest 0% APR periods are typically only available to those with good to excellent credit.
Depending on the credit card issuer, you can use a balance transfer card to transfer high-interest credit card debt and possibly other types of loans to the card. You will pay a balance transfer fee―typically 3% or 5% of the amount transferred—that is rolled into your balance on the new card. And, if you don't pay off the balance within the promotional period, you'll end up paying the regular APR on any balance carried over.
2. Cash-Out Refinance
A cash-out refinance replaces your current mortgage with a new, often larger loan that gives you the difference between the amount you borrowed and what you owe on your home in cash. Many lenders let you borrow up to 80% of your home's value, though the maximum varies.
Because you're using your home as collateral, if you struggle to make your new mortgage payments, you risk losing your home to foreclosure. You can also expect to pay 2% to 6% of the amount of your new loan in closing costs. Still, if you're using a cash-out refinance as an alternative to a debt consolidation loan and paying off high-interest debt, you could save money on interest charges—and potentially get a better interest rate or shorter term than you had with your previous mortgage.
3. Home Equity Loan or HELOC
A home equity loan is a second mortgage that lets you borrow against the equity in your home. You receive a lump sum in cash that can be used for many reasons, including consolidating debt. Your interest rate is typically fixed, with loan terms usually ranging from five to 30 years. Depending on how much equity is built up in your home, the loan amount can be quite large.
Keep in mind that qualification requirements vary from one lender to the next, and you will generally need a credit score at least in the mid-600s, although a score of 700 and above will give you a better chance of getting a loan with a competitive interest rate and good terms. A home equity loan is secured debt, putting your home at risk if you miss payments or default on your loan.
A home equity line of credit (HELOC) is a revolving line of credit, much like a credit card, that you can use to consolidate high-interest debt. Usually, you draw on your line of credit for 10 years—the draw period—and make interest-only payments during this time. The repayment period, typically 20 years, begins at the end of the draw period. Like a home equity loan, a HELOC is a second mortgage secured by your home. Default on your line of credit, and you could lose your home.
4. Budget Adjustment
Your budget is a game plan for your finances. If you don't already have one, creating a budget is an important step to reining in spending. Like any good plan, it should be revisited and adjusted as needed. You can even try a new budgeting method based on your spending habits. But if you find your expenses are greater than your income, you may feel the need to borrow to maintain your current lifestyle. Instead, review your spending and see where you can make cuts and reduce expenses.
Skip dinner out for a home-cooked meal instead. Find ways to save, like cutting back on groceries and timing errands so you use less gas each week. Consider future expenses and modify your budget as necessary so that racking up charges on your credit card doesn't become a habit.
5. Debt Settlement
Debt settlement is an alternative to a debt consolidation loan that you may consider when you have no other options besides bankruptcy. The process involves negotiating with lenders with the hope they will accept less than what you owe them. Debt settlement companies can manage the process for you—for a fee. But working with a debt relief company will seriously damage your credit and can be risky, with no guarantee it can make your debt go away. Look at alternatives first, like working with a nonprofit credit counselor, getting on a debt management plan or negotiating directly with the creditor yourself. You never know if a creditor will work with you unless you ask.
6. Bankruptcy
Bankruptcy is a legal process to reduce or eliminate many of the debts you can't pay or provide you a plan to repay your debts. Although bankruptcy may get you some reprieve from debt, it has a serious long-term effect on your credit. That's because bankruptcy stays on your credit report for seven to 10 years, making it very difficult to open new credit, like loans or credit card accounts. If you are extended credit, you may be required to pay high rates and wrestle with unfavorable terms.
That's just one reason why it's so important to begin rebuilding your credit as soon as possible by paying your bills on time and taking care not to fall back into negative habits that forced you into bankruptcy in the first place.
The Bottom Line
When you owe on a loan or credit card, you have to pay it back, most often in scheduled monthly payments. While taking out a debt consolidation loan may give you access to money today, you may have difficulty qualifying for terms to make it worthwhile. To see if a debt consolidation loan may be right for you, you can see multiple loan offers matched to your credit profile for free with Experian's comparison tool.
Some of the alternatives may offer better rates and terms to help you stay on top of your debt. Regardless, making sure you don't relapse back into the bad habits that got you in debt in the first place is imperative for a secure financial future.