How to Consolidate Debt the Right Way

Haunted by the ghosts of financial past? If you’re like the 40 percent of Americans who can’t afford to pay bills, something clearly has to give. Whether plagued by high APR credit cards or old loans you can’t afford anymore, past borrowing mistakes have a significant effect on your financial future. Luckily, debt consolidation — if properly executed — can provide effective course correction.

Debt consolidation is the process of combining several small loans into one large one — think of it like a universal remote for personal finance. Not only does debt consolidation help organize all loans into a neat package, but it can also save you a lot of money.

How debt consolidation saves money

If you have several outstanding loans, all with varying interest rates, it’s possible that an outlier could be costing you. Say, for example, a car loan you took out in your younger years — when you were still building credit — has a higher interest rate than your other loans. That one blemish on your lending history is likely costing you over time.

In this instance, a balance transfer to a low-interest loan, or low APR credit card, could help balance out high interest anomalies, and reduce debt.

Debt consolidation methods

There are several ways to consolidate debt, and picking the right method is important to maximizing savings. Here are a few of the most popular approaches to debt consolidation:

• Personal loan — This is the most common method, and fairly simple to implement. All you have to do is take out a debt consolidation loan, transfer outstanding balances, and pay off debt through this one, centralized payment.
• Home equity — If you’re a homeowner, you can take out a loan or line of credit against your home equity. This type of lending is secured by your house, but if you fail to make payments you could put your property at risk.
• Credit card — Credit card consolidation works similarly to the personal loan option. Here’s how it works: choose a low interest card (maybe an introductory 0 percent APR), pay off debt with the card, and then pay off the card. Through this method you are essentially distilling a high-interest loan through a low interest credit card. But make sure you’re aware of the interest rate once the introductory period wears off to ensure that you will still be able to manage the payment on any remaining balance. Some of these offers have interest rates that jump to more than 20 percent once the zero-interest period expires.
• 401(k0 — A less common, but still effective, version of consolidation is paying down debt through 401(k) funds. Under the pretense that you will — without a doubt — reimburse this retirement account, this method is effectively a personal loan where you’re paying yourself interest. The downside? Failure to repay yourself could exhaust your nest egg and lead to further financial issues that follow you into your retirement years.

How credit affects debt consolidation

In most cases, the success of consolidation is predicated on an improved credit score (compared to when you initially borrowed money). After all, the goal is to transfer high-interest lending to a more favorable account. So, given that an improved credit score can lead to a low interest consolidation loan, how can you effectively fix credit and start consolidating debt?

Start with the fundamentals. Get the help you need, and partner with a credit repair service to boost your FICO score, and improve the efficacy of debt consolidation.

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