Borrowers who seek to consolidate their debts today have more options than ever before. Student loans, credit cards, car payments and other types of debt can be moved around in many different ways to get ahead of the curve. Knowing the pros and cons of each strategy can help you determine which path is best for you and save you thousands of dollars – and your credit score as well.

1. Credit Card Consolidation

This strategy is probably the most effective if you are able to move your current credit card balances onto a new card that is charging a teaser rate of zero percent interest. For example, if you just opened a new card that will charge nothing for the next 18 months – and you have $5,000 of debt charging you 26% interest – moving your balance over is a logical move. Be sure to use the grace period to pay down as much of your balance as possible so that your balance (and payment) will be as low as possible when the interest kicks back in.

You could also use this card to pay off other types of debt, such as student loans or car loans, but this makes sense only if you know you will have the resources to do so. For example, you are being threatened with repossession of your car, but know you will receive a Christmas bonus that will enable you to pay off the remaining loan balance. Moving some or all of what you owe onto a credit card could allow you to keep your car until the bonus comes through. This will also prevent having a repossession appear on your credit report. If you have trouble controlling your spending, however, credit card consolidation may simply provide an avenue for racking up further debt. If this is the case, consider alternative consolidation strategies.

2. Home Equity

Homeowners who have accumulated material equity in their residences may be able to tap into this to pay off other debts. (See Using Home Equity Loans For Debt Consolidation.) This can be a good idea if the other debts are high-interest or in serious default, but be sure to run the numbers on this idea before taking action. When you've borrowed against your house, you could face foreclosure if you can't pay the bill. However, responsible spenders who are simply looking for a lower-cost alternative to their current debt structure can exchange the nondeductible interest charged on their current obligations for deductible interest on their home loan. A cash-out refinance may be another viable alternative, especially if you are already planning to refinance your loan. This could allow you to get a lower rate on your new first mortgage, pay off your other debts with the cash you get and then pour the money that was previously going to those debts back into your home.

3. Personal Loan

A friend or relative willing to front you money may be the best possible alternative when your credit is bad. Of course, this works best when they charge you a reasonable interest rate and you are certain that you can make the payments. But this option can be fraught with peril; not repaying the loan may fracture your relationship. It is a good idea to write out a clear contract that delineates the loan's term, the consequences of late payments or a default, and how interest will be computed and charged.

4. Debt Consolidation Loan

Many companies offer personal loans that allow you to consolidate your debts into a single monthly payment. The idea is that they negotiate with your creditors to get you lower payments, then lend you enough to cover them with a low-enough monthly payment for you to afford. You then make this payment to the company, which will forward a portion to each creditor. Be sure to carefully research any company that you use for this; a legitimate firm will help you improve your credit score and actually get you back on your feet. However, a substantial percentage of these companies are unscrupulous predators that charge a hefty sum up front and make only a cursory attempt to negotiate with your creditors for lower payments. Check out the National Foundation for Credit Counseling for advice and read Credit And Debt Management: Credit Counseling before you sign with anyone.

5. Student Loans

Paying educational costs can be taxing for both parents and students. But there are a few rules to remember when you consolidate these loans that don’t apply to most other types of debt. Federal student loans usually have a cap on their interest rates that prevents them from rising above a certain level, so think carefully before you fold them into some other type of debt. If you want to consolidate them separately, go to the Federal Direct Consolidation Loans website. Private student loans may be a better target for consolidation, but remember that you don’t have to itemize deductions to be able to write off student-loan interest. Three lenders that currently offer consolidation programs for private student loans: Chase, Wells Fargo and Student Loan Network.

6. Secured Loans

If you own other property you can use as loan collateral, this may be a better alternative than taking out a home loan, as it allows you to avoid risking your residence in the event you default on the loan. A vacation home or other recreational item is probably the best choice here, as pledging your vehicle or other necessary item can be almost as disruptive as being threatened with foreclosure.

7. Loans from Qualified Plans

This strategy has two main advantages. First, your retirement plan administrator will probably charge a reasonable interest rate. For example, government employees who borrow from their Thrift Savings Plans will only pay the interest rate that is currently paid out by the government bond fund (G Fund). There is also no underwriting or credit check for this type of loan. However, failure to repay the loan according to the terms set forth by your plan charter can result in a taxable distribution and early withdrawal penalty – and also deny you the long-term growth you could have reaped from keeping the money in your retirement plan.

The Bottom Line

You can consolidate debts in many ways, but some strategies carry greater risk than others. The strategies shown here reveal that there is often a tradeoff between the amount of risk and liability that you carry and the terms of the consolidation. For more information about how to consolidate your debts effectively, consult a consumer credit counselor or your financial adviser.

Related Articles
  1. Credit & Loans

    7 Tips For The Do-It-Yourself Debt Manager

    Take charge of your finances in seven simple steps.
  2. Budgeting

    Digging Out Of Debt In 8 Steps

    The only way to get out of debt is to roll up your sleeves and start paying it off - one dollar at a time.
  3. Credit & Loans

    Debt Consolidation: When It Helps, When It Doesn't

    Here's the smart way to use a debt consolidation to get your financial life back on track
  4. Credit & Loans

    Using Home Equity Loans For Debt Consolidation

    A home equity loan or line of credit is a convenient way to consolidate debts, cut your interest rate and gain a tax deduction. But there are big risks.
  5. Credit & Loans

    Debt Forgiveness: How to Get Out of Paying Your Student Loans

    Though many individuals eagerly await the possibility of student loan forgiveness, strict stipulations and changing laws may leave some debt-burdened grads with huge un-paid tabs and reduced ...
  6. Budgeting

    Debt Consolidation Made Easy

    These five steps can help get you out of debt faster and easier than you'd ever imagined.
  7. Credit & Loans

    6 Ways To Keep Aggressive Debt Collectors At Bay

    Get an upper hand on debt collectors by knowing your rights and using these tips.
  8. Personal Finance

    What's Your Debt Really Costing You?

    Although your minimum monthly payment may not look like much, your debt is denting your finances more than you realize.
  9. Credit & Loans

    Debt Collection: Know Your Rights

    Learn about the debt collection process so you know how to handle it if it happens to you.
  10. Credit & Loans

    Credit And Debt Management

    America is addicted to debt. Learn how to manage your credit and keep debt from ruining your life.
RELATED TERMS
  1. Debt Consolidation

    The act of combining several loans or liabilities into one loan. ...
  2. Debt/Equity Ratio

    1. A debt ratio used to measure a company's financial leverage. ...
  3. Credit Rating

    An assessment of the credit worthiness of a borrower in general ...
  4. Long-Term Debt

    Long-term debt consists of loans and financial obligations lasting ...
  5. Revenue-based Financing

    Revenue-based financing, also known as royalty based financing, ...
  6. Jamming

    A scam perpetrated by bogus credit repair firms that involves ...
RELATED FAQS
  1. Why would someone change their Social Security number?

    In general, the Social Security Administration, or SSA, does not encourage citizens to change their Social Security numbers, ... Read Full Answer >>
  2. Can my IRA be used for college tuition?

    You can use your IRA to pay for college tuition even before you reach retirement age. In fact, your retirement savings can ... Read Full Answer >>
  3. What is the formula for calculating weighted average cost of capital (WACC) in Excel?

    When analyzing different financing options, companies need to look at how much it will cost to fund operations. There are ... Read Full Answer >>
  4. Why can additional paid in capital never have a negative balance?

    The additional paid-in capital figure on a company's balance sheet can never be negative because companies do not pay investors ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. How many votes am I entitled to, if I own ordinary shares of a company?

    If an investor owns one ordinary share of a company, that investor is entitled to one vote on all of that company's major ... Read Full Answer >>

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!