Several months ago, many of us made New Year’s resolutions vowing that in 2018 we would eat better, spend less, exercise more, and maybe even organize our closets. Another common resolution many people make for the New Year is to get their debt under control. For some—especially after a holiday season of gift giving, travel, and restaurant meals—this can be done by just paying off a little extra each month. But for others, who may be starting 2018 feeling overwhelmed by mounting debt, numerous monthly payments, and balances that never seem to go down, a larger solution may be needed.
Debt consolidation is a good way for people in this situation to manage their personal finances by putting much of their debt in one place. This can mean lower interest rates, fewer monthly payments to keep track of (which can also eliminate late fees), and a final date for when it will be completely paid off.
There are many ways to consolidate debt and they each have their own set of positives and negatives. Choosing the best for you depends on your own financial picture including the amount of your debt, your debt history, your income and credit score, and whether you have property, such as a car, that could be used to secure a loan. Some common options include:
- Home equity loans - If you own your home and have equity in it, you can take a home equity loan or line of credit. The interest rates tend to be lower than other types of loans, but these often take ten years to repay and you risk losing your home if you can’t repay the loan.
- Loans against retirement funds - If you have a 401(k)-retirement plan, you can take a loan against it. These loans typically last five years and don’t show up on your credit report. However, there are heavy penalties if you can’t repay it and, if your retirement plan is employer-based, you will have to pay it back very quickly if you quit or lose your job (usually within 60 days).
- 0% credit card transfers - Some credit cards will offer new customers 0% interest on balance transfers from other cards. This option is more common among people with higher credit scores (who don't have multiple credit cards), but can also be available to some with less than prime credit. It’s also only useful to those with relatively low debt because you often have just 12 to 18 months to pay it all back before the interest rate increases substantially. Additionally, a one-time fee may be added to your balance when you make the transfer (this is often something like 3% to 5% of the transfer balance).
- Personal loans - Personal loans are actually the most common way to consolidate debt. In fact, debt consolidation is one of the top reasons people come to OneMain Financial. There are two types of personal loans—secured and unsecured. A secured personal loan is one with collateral — often your car. The benefits of a secured personal loan are that the interest rate is lower, you often will be approved for more money, and the payments each month are typically lower. If this is not an option, you can go with an unsecured personal loan. Interest rates on these types of loans vary based on your credit score and other factors. With either of these personal loans, you have a fixed payment period such as three or five years, and you make one payment each month. This way, you know that when the loan ends, your original debt and the interest will be paid back. An added benefit of a personal loan is that it can actually improve your credit score moving forward, as long as you pay it back on time.
The most important note about debt consolidation, however, has to do with what you do next. When you consolidate debt, you free up credit cards that may have been at or near their spending limit and lenders start offering you new cards. Using too much credit at this point will undo the progress you made by consolidating debt and get you right back into the revolving door of minimum payments that never seem to make a dent in your overall balance.
So, as you’re looking at your options and deciding what makes the most sense for you, take time to make a budget that includes your estimated new consolidated monthly payment (many lenders will help you estimate this before you commit to the loan), and a plan to cut down on spending wherever possible. Then stick to it and let next year’s resolution be about something entirely different—like making it to the gym three times a week, cutting down on sweets, or finally organizing your closet.