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Credit Management

Debt Consolidation 101: Is It Right For You?

debt consolidation 101

If you’re struggling with debt, chances are there are two words you’ll hear repeatedly as a possible solution: debt consolidation. Even so, when it comes to the process, you might be confused where to start. In this post we’ll cover debt consolidation 101.

First, what is debt consolidation?

Let’s say you owe money on three credit cards. Each charges you on a different payment schedule and at a different interest rate—a fairly complicated process to manage. Consolidating your debt means you put it all together to refinance it. In other words, you change its terms and schedules by putting it all in one place via an agency or lender. This means you have only one monthly payment at a new (often lower) interest rate. The lender then sends tailored payments to all your original creditors. This can make life a lot easier—you know exactly how much you need to pay each month, where that money is going, and it may even help improve your credit score.

To decide if debt consolidation is right for you, ask yourself these questions:

  • Do you have a lot of unsecured debt? Unsecured debt is any debt that does not have physical property as collateral against it, like your credit card bills. If yes, then consolidation is a good option. Don’t consolidate against secured debt, like your home, or you may end up losing it if you miss payments.
  • What are the APRs on your credit cards? The average credit card rate can range from 16 to 19 percent, but when you don’t pay your minimums, this range jumps to 23 to 29 percent. If you are in the latter range, you should look to consolidate, as you will likely get a better rate.
  • Do you have good credit? Your credit score will dictate how low a rate you can get. If you have a credit score of 640 and above, online marketplace lenders such as Prosper could be a great option to make it easy for borrowers to consolidate high-interest debt. Instead of juggling multiple bills with varying high interest rates, you can take out a loan to pay off all your debt, and then simply repay the one loan at a lower interest rate. Loans offered through Prosper have rates that are typically lower than credit cards. In addition, loans are fixed-rate, fixed-term with no prepayment penalties.

If you want to explore consolidating your debt, here is what to do next.

  • Set up a counseling session. A credit counselor  can help you look at your finances holistically and identify the best avenue to reach your debt-free goals.
  • Do the math: Consolidating via a marketplace lender like Prosper can save you a lot of money. Let’s say you put a $10,000 medical expense on your credit card. According to Bankrate.com, if you just pay the minimum each month, it will take 28 years to pay off your debt, and you will end up spending more than $12,000 in additional interest payments.[1]  Compare that to marketplace lending, where you can pay off your debt in three years with a fraction of the interest payments—savings could amount to more than $11,000.[2]
  • Research a good credit agency. Many agencies have high service fees and interest rates that are very comparable to other creditors, so do your homework. Look for an agency that belongs to either the National Foundation for Credit Counseling or the Financial Counseling Association of America. Marketplace lending is a smart approach for debt consolidation because of its low interest, fixed rates, fixed terms, and lack of prepayment penalties or hidden fees. It’s also fast, with most people getting their money in 3-5 days.
  • Know that your work isn’t done. Refinancing your debt is only the first step. As you would with a credit card company, make sure to stick to your plan to make timely, regular payments over the course of your loan term. Remember that your debt still exists—it just looks different (and a lot better!).

If all of this sounds and looks overwhelming, don’t be deterred. You’ve taken the first step of educating yourself about your options. With the right partner and some reorganization, discipline, and perseverance, you will be on your way to financial well-being.

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[1] According to the Bankrate.com Minimum Payment Calculator (http://bit.ly/wBsq2). This estimate assumes a 16.00% interest rate and a minimum monthly payment equal to 1% of the outstanding balance plus any new interest. Your actual minimum payment, payoff time, and payoff cost will depend on your account terms and any future account activity.

[2] This is based on a three year $10,000 loan with a Prosper Rating of AA and a rate of 5.32 % (5.99% APR) would have 36 scheduled monthly payments of $302 resulting in total interest charges of $842.  To qualify for an AA Prosper Rating, applicants must have excellent credit and meet other conditions.  Between October 1, 2014 and September 30, 2015 the average three-year loan rate presented to other pre-approved applicants was 12.8% (16.0% APR).

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