A guide to debt consolidation

Credit, Financial education

Being in debt can be stressful, especially if you have multiple payments to worry about. Thankfully, there is a way to streamline your debt so that you have one payment plan to worry about. It’s called debt consolidation.

There are several options for consolidating your debt. Want to find the best loan for your situation? We can help.

Here’s what we’re going to cover:

  • What is debt consolidation?
  • Personal loans
  • Home equity loans
  • 401(k) loans
  • Getting a loan if you have a low credit score
  • Oportun: Affordable personal loans for debt consolidation
Key takeaways:

  • Debt consolidation is the process of grouping all or some of your debts into a single account. By consolidating your debt, you enjoy the convenience of having only one debt payment plan. You might also be able to get a lower interest rate or pay off your debt faster.
  • Personal loans can be used for debt consolidation. You can also consolidate your debt with a home equity loan or a 401(k) loan, but these options carry more downsides.
  • Even if you have a low credit score, there are several strategies that can help you get a loan to consolidate debt. You could apply with a cosigner or apply for a secured personal loan. Or you might want to wait until your credit score has improved.

What is debt consolidation?

Debt consolidation is the process of grouping all or some of your debts into a single account. When you take out a debt consolidation loan, you use that money to pay off your existing debts. Then you owe just one regular debt payment.

Streamlining your payments this way can make it easier to keep track of what you owe and plan for it in your budget. It can also reduce your stress by helping you feel more in control of your finances.

In addition, you may also be able to take advantage lower interest rates. Credit cards, for example, typically have higher interest rates than loans. By transferring your credit card debt to a lower interest loan, you may be able to save money in the long run.

There are three main types of loans you can use for debt consolidation:

  • Personal loans
  • Home equity loans
  • 401(k) loans

Each of these loan types has benefits and drawbacks when you’re consolidating debt. Let’s take a look at each type in detail.

Personal loans

Personal loans are often used to pay for big expenses like medical bills, home improvements, and car repairs. They’re also a popular tool for consolidating debt.

Here are some of the benefits of personal loans.

Loan term options. The loan term is the amount of time you have to pay back your loan. Personal loans typically have terms of one to five years.

You can make your payments more affordable by choosing a longer loan term. This will spread your total debt over a longer period of time, so the individual payments are smaller. However, you may owe more money in interest this way. You can work with your lender to find a loan term that’s right for your financial situation.

Fixed interest rates. When your loan has a fixed interest rate and a fixed term, each of your payments will be the same amount. This makes it easy to plan for them in your budget. You know exactly how much you will owe each month.

Optional collateral. Collateral is something of value that you promise to give your lender if you fail to make your loan payments on time. Most personal loans don’t require any collateral. Those that do are called secured personal loans. Secured loans are usually easier to qualify for, especially if you have a limited credit history or a low credit score.

What is a credit score?
Your credit score is a number between 300 and 850 that gives businesses an idea of how likely you are to make payments on time.

Home equity loans

If you own a home, you can also consolidate your debt using a home equity loan. These loans borrow money directly from your home’s equity.

What is home equity?
Equity is the difference between your home’s market value and the amount you still owe on your mortgage. You can think of equity as the portion of your home that you currently own.

 
Home equity loans have fixed interest rates, fixed terms, and predictable payments.

The main drawback to this debt consolidation method is the risk. You have to use your home as collateral. If you fail to make your home equity loan payments on time, you could face foreclosure. If your home’s market value goes down during the loan term, you could also end up owing more money on your loan than your house is worth.

401(k) loans

Another option for debt consolidation is a 401(k) loan. With this type of loan, you borrow money from your 401(k) retirement account. Because you’re borrowing your own money, you don’t have to pay interest to a lender.

However, 401(k) loans have many restrictions that make them a less desirable option for debt consolidation.

  • You must have an established 401(k) account
  • You can borrow no more than $50,000, or 50 percent of your 401(k) account’s balance
  • You may be charged a 10 percent tax penalty if you default on your loan

Another downside is that the money you borrow from your 401(k) won’t earn interest while it’s being used for the loan. If you normally earn interest on your 401(k), this means you will be earning less money for retirement.

Getting a loan if you have a low credit score

If your credit score is 650 or less, you may find it difficult to get approved for a loan to consolidate your debt. Even if a lender approves your application, they may charge you a high interest rate.

There are several strategies that can help you get a loan to consolidate debt if you have a low credit score.

Apply with a cosigner.
A cosigner is someone who adds their name to your loan application and agrees to pay back the loan if you cannot. If your cosigner has a high credit score, their good credit can increase your chances of getting approved for the loan. Just remember that if you fall behind on your loan payments, the lender may ask your cosigner to pay instead.

Apply for a secured personal loan.
You might also have a better chance of getting approved by applying for a secured personal loan. This type of loan requires you to put up some kind of collateral, like your house or car. Secured personal loans are usually easier to qualify for than unsecured loans.

Wait until your credit score improves.
A third option is to work on improving your credit score before you apply for a debt consolidation loan. By taking the right steps, you could increase your credit score in as little as six to 12 months.

Oportun: Affordable lending options designed with you in mind

Now that you understand how debt consolidation works, you can learn about how Oportun may be able to help you if you’re looking for affordable credit options.  Visit our homepage to learn about:

  1. Personal loans
  2. Credit cards
  3. Secured personal loans
  4. And more!

 

Sources:
The Pew Charitable Trusts. The complex story of American debt
Consumer Financial Protection Bureau. Mortgage key terms

 

The information in this site, including any third-party content and opinions, is for educational purposes only and should not be relied upon as legal, tax, or financial advice or to indicate the availability or suitability of any Oportun product or service to your unique circumstances. Contact your independent financial advisor for advice on your personal situation.

Personal loans through Oportun subject to credit approval. Terms may vary by applicant and state and are subject to change. If you refinance, you may pay interest over a longer period of time or at a higher rate and the overall cost of your loan may be higher. Loans in AZ, CA, FL, ID, IL, MO, NJ, NM, TX, UT, and WI are originated by Oportun, Inc. California loans made pursuant to a California Financing Law license. NV loans originated by Oportun, LLC. In AL, AK, AR, DE, GA, HI, IN, KS, KY, LA, MI, MN, MS, MT, NC, ND, NE, NH , OH, OK, OR, PA, RI, SC, SD, TN, VA, VT, WA, and WY loans are originated by MetaBank®, N.A., Member FDIC. Terms, conditions, and state restrictions apply.

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