How to Consolidate Loans
If you've watched TV or opened your mail lately, you know that there are plenty of companies eager to help you consolidate your loans to "cut your payments in half", "lower your interest rates", and "help you get out of debt fast". Indeed, consolidating your high interest loans and credit card debt into a single loan with a lower interest rate and more manageable payments makes perfect sense. Unfortunately, it doesn't always work out that way––many people who consolidate their loans end up paying far more than they would have otherwise. And in the case of home equity loans, an alarming number of borrowers end up losing their homes. Add to this the fact that many so-called "consolidation" programs aren't really consolidation loans at all, and debt consolidation, rightfully, has a bad reputation. Still, you may be able to benefit from consolidation if you explore your options and proceed with caution.
Steps
- Get your credit report and FICO score Any loan you get will be based largely on your credit score, so you should find this out. However, if your credit score reveals that you actually score quite well and have a reasonable credit rating, you may easily be able to consolidate loans at a lower rate, especially if your credit has improved since you got the loans.
- Go over your entire credit report carefully to make sure it's accurate. Inaccuracies can hurt your score and keep you from getting the rate your deserve.
- Consider all your options. Before you jump into a debt consolidation loan, think about your other options:
- If you just want to save money, but you're not in dire straits, simply pay off your debts fast by prioritizing them. Pay as much as you can each month on your highest-rate loan while making minimum payments on your others. This way, you're able to lower your monthly finance charges as quickly as possible.
- Call your credit card company. If you have relatively good credit, you may be able to simply talk to your credit card company and negotiate a lower interest rate. If they won't give you a lower rate, you may be able to transfer your balance to a credit card with a lower long-term rate or a no-interest introductory rate––just make sure you know what your rate will be after the introductory period.
- Contact a credit counseling agency. A reputable credit counseling agency can provide you with free or low-cost advice on how to manage your debt, and they can help you prepare a budget to get your finances under control. Credit counseling, however, does not necessarily mean entering into a debt management program, and you should beware any organization that tries to push you into such a program immediately. In general, be careful when choosing a credit counseling agency. Even agencies that are registered non-profits frequently charge high fees.
- Sell your car. If you can't afford your car payments, try to sell your car to pay off the loan. If the car gets repossessed, it will end up costing you even more money.
- Talk to your mortgage lender. Reputable mortgage lenders will usually work with you if you have some temporary trouble paying. Call them as soon as you know you'll have trouble, and they may temporarily suspend your payment or accept reduced payments. You might also be able to extend the time for repayment, thereby reducing your monthly payments or you might pay interest only (not the principal), reducing the payment amount for a time. Make sure you find out about any additional fees or penalties for any arrangement, and consider refinancing your home if you can get a better interest rate.
- Borrow from your life insurance. Whole life policies usually allow you to borrow against the cash value of the policy. This easy, usually low-interest, loan can get you quick cash to pay off debts. Be sure to check on the tax implications of borrowing, and understand that if you don't repay the loan it will be subtracted from the amount your beneficiary receives.
- Understand the difference between a consolidation loan, a debt management program, and debt negotiation. Companies that claim to be able to help you lower your payments or get out of debt quickly may appear to be offering consolidation loans––they may even have the word "consolidation" in their names––when in fact they use methods such as debt management, settlement, or even bankruptcy. There are major differences between these options:
- A consolidation loan is simply a loan that pays off your other loans. Once you consolidate a loan, you owe that money to the new lender, not to the original creditor. A consolidation loan may lower your monthly payments, either by reducing your interest rate or by extending the length of time for repayment, but it pays off the other creditors completely. Consolidation loans may temporarily blemish your credit, but generally to nowhere near the extent of debt management programs or debt negotiations.
- Debt management programs may also reduce your payments, but they work differently. A debt management agency acts as a middleman between you and your creditors and tries to negotiate a reduction in the interest rates or fees on your loans. You then pay an agreed amount to the debt management or credit counseling agency, and they disburse the payment (usually minus a fee) to your creditors. Participation in a debt management plan usually shows up on your credit report, and may adversely affect your credit rating.
- Debt negotiation is the act of settling a debt for less than what you owe. You pay a part of what you owe to a creditor, and the creditor writes off the rest of the debt. Credit card companies often offer lump-sum settlements as a way to recoup part of their losses. While you end up owing less, a settlement will bruise your credit, badly. Worse still, third-party companies that offer debt negotiation have been known to disguise their practices as consolidation, and these companies frequently charge exorbitant fees while simply passing along payments to your original creditors, sometimes failing to even negotiate any difference in your repayment terms.
- Aim to pay off your debt quickly. One of the most attractive features of consolidation loans is the potential for lower monthly payments. But if the reduced payment is just the result of spreading your repayment over a longer period of time, you'll most likely be paying more––sometimes far more––with the consolidation than you would have otherwise. Figure out your budget and set your monthly payment as high as you safely can. You'll end up paying less, and you'll get out of debt quicker.
- Get the right loan for you. Debt consolidation loans can be secured (backed up by collateral) or unsecured (also often called "personal loans"):
- Secured loans, such as second mortgages, secured lines of credit, or home equity loans, will typically have lower interest rates than unsecured loans because if the borrower defaults on the loan, the lender can recoup the money by selling the underlying asset. Interest on a home equity loan may also be tax-deductible, a feature that may save you more money. Keep in mind, however, that if you fall behind on a home equity loan, the lender can foreclose on your house.
- Carefully consider the risk before opting for any secured loan. Also keep in mind that such loans may include hidden fees such as "points" (a point equals one percent of the amount borrowed), that may drive up the cost of your loan.
- Unsecured loans are a safer option, because you don't have to risk your house or other assets. If you have good credit, you should be able to get a decent rate (at least compared to credit cards) on an unsecured personal loan. Depending on your situation, however, especially if you have poor credit, you may find that only a secured loan will get you a lower rate than what you're currently paying.
- Secured loans, such as second mortgages, secured lines of credit, or home equity loans, will typically have lower interest rates than unsecured loans because if the borrower defaults on the loan, the lender can recoup the money by selling the underlying asset. Interest on a home equity loan may also be tax-deductible, a feature that may save you more money. Keep in mind, however, that if you fall behind on a home equity loan, the lender can foreclose on your house.
- Shop around. Get quotes from several different lenders, and compare the terms and interest rates carefully. Your own bank or credit union is often your best bet, particularly for personal loans, but it's a good idea to shop around.
- Get quotes in writing so you can compare lenders side-by-side. There are also websites that allow you to compare several lenders.
- Make sure you understand all the fees associated with the loans, as well as the conditions of the loan. If you want to get a solid price for the loan, you'll need to actually apply, as the final interest and fees may vary considerably from those quoted. Get as accurate a quote as possible by providing only accurate information.
- Compare the total cost of consolidation to your current situation and to other consolidation loans. Don't just pay attention to the monthly payment. That's how consolidation companies lure you in, but even with the lower payment you may end up paying a whole lot more under the consolidation. Instead, consider how much you'll pay for a consolidation loan, including the interest, upfront and recurring fees, closing costs and points (for secured loans), and any tax implications, over the life of each loan. Choose the best option and then compare it to the total amount you'll have to pay to pay off your current loans (if you were to not consolidate). If you can realize substantial savings on the total cost of the loan, consolidation is probably a good option.
- Read your loan contract carefully. Read every word, and then read every word again. Ask any questions you may have, and make sure you understand the answers, no matter how many times you have to ask. If in doubt, get a lawyer or another knowledgeable, independent source to take a look at the documents for you. Something that seems inconsequential in a contract can end up costing your thousands of dollars or even your home, so do your due diligence.
- Reject credit insurance. Some lenders will attempt to pressure you into buying credit insurance, either by extolling its virtues, implying that your application will be rejected, or hiding it from you. If a lender does either of the latter two, get out of there and file a complaint with the appropriate authorities (in the U.S., the Federal Trade Commission (FTC) handles complaints, as do many state attorneys general). Credit insurance can add a huge cost to the loan, and it generally offers you very little protection. The lender may make the cost seem small by telling you the monthly price, but don't be fooled.
- Finalize the loan. If your loan hasn't already been approved, complete the full application process. This should be straightforward, but it can take some time and footwork. If your loan rate is different from that which you were quoted, find out why, and then check with your next best option. Don't get taken by the old bait-and-switch.
- Control your spending. If you're looking to consolidate because you've gotten in debt over your head, there's no time like the present to take a good look at your budget and balance it so that you don't continue to dig yourself in.
This video shows instructions slightly different than that described in the text steps above but provide similar advice.
Tips
- The lender may provide you with the total cost of the loan, but if they don't, it's easy to calculate. Simply multiply the monthly payment by the number of months in the loan, and then add any fees or points. It's a good idea to do this even if the lender does quote you a total cost figure.
- There are online calculators with which you can compare the cost of your current debts with the cost of a consolidation loan, but be careful with them. Those on some lenders' sites assume a low rate for the consolidation loan and high rates for your other loans. While this may be the case, it's not always, and you won't get an accurate comparison if you can't enter the correct interest rates. Also, be sure to add in any fees.
- When deciding on a monthly payment amount, be sure to give yourself a little safety cushion, especially for a secured loan. While you want to pay off the debt as quickly as possible, you don't want to get into a situation where you can't afford the payment if something unexpected comes up.
- If you're not familiar with a lender, do some research. Check to see if there have been any complaints filed against it with the Better Business Bureau or the Federal Trade Commission, and search for the lender on the internet to see if you can find any interesting information. Regardless of the lender, however, make sure you understand the terms of your loan fully.
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- Treat debt consolidation as a way to pay off your debts, not as a way to free up extra spending money. You've got to control your spending or you'll just go deeper and deeper into debt.
- The worse your credit, the higher the interest rate you can expect to pay. It also seems to be the case that the direr your situation, the more companies will try to take advantage of you. Be realistic, but make sure to explore all your options. Above all, make sure you completely understand all the terms and conditions of your loan, and watch out for excessive fees.
- Debt may be the symptom of a deeper problem––unless you solve the underlying problem, you'll soon be back in debt, only you'll have the consolidation loan along with all the others. Get yourself on a spending plan, aka a budget, and stick to it for several months before consolidating your debts, to prove to yourself that this is going to be a do-able route for you.