02 Jul Is a Debt Consolidation Loan a Good Idea? Experts Explain the Good, the Bad, & the Ugly
Lots of different loans from a bunch of different lenders can be stressful. You have to juggle multiple repayments and keep track of every lender. Fortunately, debt consolidation has become a popular form of debt refinancing to consolidate many different loans into one.
If you have more than one loan from more than one lender and you are struggling to keep up, debt consolidation might be right for you.
What is Debt Consolidation?
If you have different forms of debt with different credit providers, you can use a debt consolidation loan to change from having many credit providers with many monthly payments (and interest rates), to having just one.
This makes debt consolidation one of the best ways to settle your outstanding debt amounts because it aims to simplify your debt repayments. The basic mechanic of this is that many loan repayments are combined into one single loan.
The end result is that you will only have to service this one debt and not have to worry about all the other smaller ones.
Reasons You Might Get A Debt Consolidation Loan
Why should you consider debt consolidation?
The main purpose of debt consolidation is convenience. Instead of worrying and keeping track of many different loans and loan payments, you only have to worry about one. This will definitely help reduce the overwhelming stress of multiple student loans or other personal loans.
There is a possibility that your debt consolidation loan can offer you lower interest rates or monthly repayments and we explore this possibility below. Keep in mind, however, that although debt consolidation is a form of debt refinancing, this does not necessarily mean you will get a better interest rate or payment terms than your existing loans.
Debt Consolidation Vs. Debt Settlement
Another solution people seek when they are struggling to keep up with all their debt is debt settlement.
Debt settlement (otherwise known as debt arbitration or debt negotiation) is a method of negotiation used by debtors (via debt settlement companies) that results in the debtor paying a reduced amount on the outstanding loan which is regarded by the credit provider as settlement of the full loan. So basically, the debtor doesn’t need to pay back the full loan.
How does this work?
Instead of you paying the person to whom you owe the money (i.e. the bank or other lenders), you pay your monthly installments (or lump sum amounts) to a debt settlement company. The debt settlement company doesn’t pay these amounts over to the creditor, but instead keeps the money in a savings account.
Once your account with your creditor is in default, the debt settlement company uses your default as leverage to negotiate a reduced amount with the creditor. This forces the creditor to accept this reduced amount as full and final settlement of the outstanding loan.
The debt settlement company will, of course, ask a fee for this service, which should be taken into account.
Why Debt Settlement Might be a Bad Idea
Debt settlement might sound like a great option to get out of heaps of debt with you ending up paying less than you actually owe. But, you must carefully consider the consequences of this option.
You might end up paying less than you are supposed to but, in the process of negotiation, you actually stop paying your creditor. This means that the creditor registers these non-payments as defaults. For a creditor to actually settle on accepting a reduced amount, you will have to be behind on quite a few payments on their records.
These late payments get reported to credit bureaus, which means your credit score will take a significant drop. Contrary to what you might think – if you end up settling the debt with the creditor this history is not erased. Even if you can recover from the dropped credit score, the late payments will form part of your credit history and will stay there for up to seven years.
On top of this, instead of the loan being recorded as “Paid in Full” on your credit history, it will be marked as “Charged-Off Settled” or “Paid-Settled”.
This information will be available for any future lender to see and will be taken into account in determining how big a risk you are to them. This influences how much they will charge you for lending you money. This bad credit record will make it difficult to get credit in the future and it will be even more difficult to get a good interest rate.
As a last, little snag – don’t assume the amount you get off this settled loan is a freebie. The Internal Revenue Service regards debts that are written off or “forgiven” as an income to your account. This means you will have to pay tax on the amount the creditor writes off. This tax is in addition to the fee you pay to the debt settlement company.
Taking into account the bad credit history, additional tax and service fee, you might reconsider whether this option is the right one for you.
Pros and Cons of Debt Consolidation
Like with all financial decisions, there are pros and cons to consider before deciding to get a debt consolidation loan.
Why a Debt Consolidation Loan is a Good Idea
Debt consolidation can be a possible solution to three debt obstacles:
1. High interest rates
2. High monthly repayments
3. Confusion due to the number of debts that need to be managed
Debt often grows faster than your ability to pay it off due to the high interest rates associated with borrowing money. If you have had the opportunity to increase your credit score or you have secured better income since you took out your initial loans, you might be able to get a better interest rate on your debt consolidation loan than your current loans. This will save you a lot of money in the long run.
If your current total monthly repayments are killing your cash flow, you can also find relief in a debt consolidation loan. The single monthly repayment on your consolidation loan is usually less than all your other monthly payments together due to these better interest rates and extended repayment terms. This means you could have some more breathing space every month.
Just remember this does not mean you should spend all the extra cash. The money you’re now saving on your monthly repayments can be put away to assist with the longer repayment term usually associated with a debt consolidation loan.
Only having one loan to manage can definitely be a big bonus and will help you live a simpler life when it comes to your credit health.
Why a Debt Consolidation Loan might be a Bad Idea
Just as there is a chance that your consolidation loan will give you a lower total interest rate than your current loans have, there is also the chance that it might give you a higher one. The other benefits associated with a consolidation loan might not be worth it if it means it will cost you more in the long run.
As we mentioned above, you should keep in mind that a lower interest rate usually goes hand-in-hand with longer repayment periods. So you might be paying less each month, but you will be paying for longer.
Is Debt Consolidation the Right Choice for You?
Debt consolidation is only a good idea if you are in the financial situation that requires some drastic change to get ahead with your debt settlement.
The following factors will influence whether debt consolidation is the right choice for you:
Credit score – If you have a high credit score, the loan you get to consolidate your debt will have a favorable interest rate. If you have a low credit score, you might end up paying a higher interest rate on the consolidation loan than on your current loans.
Stability of your income – Remember this loan will be one big loan to pay off instead of a few smaller ones. Consolidation loans typically take 3-5 years to pay off and you need to make sure that your income can carry this liability. In the end, it will come down to the affordability of the new repayment terms.
Habits – Paying off your existing debt is only half the solution to getting out of debt. The other half is knowing what got you there in the first place and not getting into the same situation again. Debt consolidation is not a solution for reckless spending or reckless borrowing.
What are Your Debt Consolidation Options
If you decide debt consolidation is the right option for you, there are many companies that can offer you a debt consolidation loan. Below are 3 examples we picked for you.
Interest Rate / APR
6 months to 24 months
3 to 5 years
9.95% – 35.99%
2 to 5 years
Stilt offers loans from $1,000 to $25,000.
As Stilt focuses on loans for immigrants and non-residents, Stilt does not require a credit score, green card or social security number for you to be eligible for a loan. They only require you to be employed, have a US bank account and be a holder of one of the required visas.
Stilt will look at other aspects than your credit score (like your financial history and your spending behavior) to determine whether you qualify for a loan and your loan amount, rate and term will be influenced by these factors. Another perk is that Stilt also does not have any pre-payment fees, which means you won’t be penalized for paying off your loan early.
Unfortunately, Stilt does not offer the option of a co-signer. This means you won’t be able to use a friend or relative with a strong financial history to sign with you to get a lower interest rate or increase your chances of getting approved.
LendingClub provides loans up to $40 000.
Unlike Stilt, LendingClub takes your credit score into account when determining your APR and whether you are eligible for a loan. With LendingClub, your income and financial history play a big role. LendingClub focuses on those borrowers with a track record of responsible borrowing and a strong financial history. They require a minimum credit score of 600 and a minimum credit history of 3 years. You also need to have a debt-to-income ratio of less than 40% (for single applicants) or 35% (for joint applicants).
If you are an immigrant, non-resident, or you haven’t had the chance to build a credit record (or might have had a few slips in the past and our credit score is on the lower side), LendingClub might not be the right fit for you.
Avant offers loans from $2,000 to $35,000.
Qualification criteria for Avant is a minimum credit score of 580 and a minimum of $20,000 gross annual income.
Avant focusses on borrowers with low credit scores, so this is an option if you have bad credit. One of their perks is their late-payment policy. If you miss a payment by more than 10 days, you will pay a $25 late fee. But if you follow that payment up with three consecutive payments made on time, this late fee will be refunded to you.
According to Avant, half of their borrowers take out loans for debt consolidation, so this is a good option for a debt consolidation loan. Unfortunately, if you are an immigrant or you don’t have a credit history yet, Avant might not be the right option for you.
There are many different options out there if you want to get a debt consolidation loan to better manage your debt. Consider all the pro’s and con’s and make an informed decision before deciding to opt for debt consolidation and when choosing the right lender. Also remember, debt consolidation does not mean your debts are paid off – it just means that you get to manage it easier and possibly also cheaper.