If you’re flooded in debt, one option that you may have heard about is debt consolidation. There are many pros and cons to using a debt consolidation program. Keep in mind that in order to qualify, you generally need at least $7,500 in unsecured debt.
Here’s how debt consolidation works.
Debt Consolidation 101
The basis of debt consolidation works like this. Let’s say you have four different debts, all of which total up to $1,100 a month in debt payments. You simply can’t afford the payments anymore.
Instead of defaulting or going into bankruptcy, you go to a debt consolidation company.
The debt consolidation company will turn to your lenders and negotiate a deal to pay off all your loans for you. Usually they’ll get a deal for between 25% to 75% off.
They’ll pay off the loan, then you’ll owe them money instead of your previous lenders.
Instead of having to make four payments, you only need to make one. Your monthly payment is usually significantly lower than your previous monthly loan payment amount.
Keep In Mind They Need to Make Money Too
Keep in mind that debt consolidation companies, even if they’re a non-profit company, need to make money too.
Some companies will structure their program in such a way that you’re actually paying more at the end of the day. For example, they can lower your $1,100 payment down to $700 a month while extending your loan terms by 24 months.
Your monthly payment may be less, but in terms of the total loan term you may end up paying a few thousand dollars more.
It’s a trade-off: they need to make money; but if you can’t afford the higher monthly payment, then a lower monthly payment with a higher overall payment might be the lesser of two evils.
How Does It Affect Your Credit?
Settling a debt is definitely not as good for your credit as paying it off in full. However, it’s definitely better than not paying it off at all.
How it affects your credit depends in part on how delinquent you were before the consolidation. It also depends on whether or not the creditor charged off your debt to a collection agency.
If your debt has already been charged off, the charge-off will appear on your credit report even if the consolidation company reaches a settlement with the collection agency.
The act of working with a debt consolidation company does not lower your credit. However, settling for an amount lower than the total you owed, being delinquent on your debt, and getting charged off can all add up to negatively affect your credit report.
Apart from the settlement however, these would negatively affect your credit whether or not you consolidate your debt.
These are some of the most essential facts about debt consolidation. It’s not for everyone; but if you want to save yourself from bankruptcy it may be a worthwhile option.