Three common ways to consolidate loans

After deciding debt consolidation may be right for you, you’re left with one more decision. Just how will you go about consolidating your loans? Lenders provide a variety of ways to transfer some or all of your debt into a single new loan.

Depending on your situation, multiple opportunities may be available to you. Each has its own wrinkles, so let’s take a look at the pros and cons of three common ways to consolidate debt: personal loans, home equity loans, and credit card balance transfers.

Personal Loan

What is it? A loan from banks (traditional option), credit unions (flexible option), or online lenders (convenient option) that is paid back in fixed installments. Most personal loans are “unsecured” which means they’re not backed by collateral (home, car, etc.).

Benefits of personal loans:

• You’ll know your monthly payment, interest rate, and payoff date upfront.
• Since the loan is unsecured you don’t have to risk losing an asset, such as your home, if you fall on hard times and miss a handful of payments.
• Receiving rate quotes tend to be an easy process that don’t hurt your credit.

Drawbacks of personal loans:

• Structuring a loan costs money so the institution may charge an origination fee of 1-5% of the loan balance.
• Lenders tend to charge higher interest on personal loans since they can’t take your property if you can’t pay the loan.

Great when: You’re looking for a clear repayment schedule and you don’t want to tie your assets to debt.

Home Equity Loan

What is it? Home equity is the portion of your home that you’ve paid off - the market value of your home minus the remaining mortgage. You can tap into your equity to pay off debts by either a home equity loan or a home equity line of credit. A home equity loan functions like a personal loan - fixed payments over a determined duration. A home equity line of credit (HELOC) functions like a credit card. You get a loan with a pre-approved limit to use at your will with variable payments.

Benefits of home equity loans:

• Loans typically have lower interest rates when lenders have your home to fall back on. This means less costs for you as long as you pay as agreed.
• You may be eligible to deduct interest paid on your tax return. Be sure to check with a tax professional to determine your eligibility.

Drawbacks of home equity loans:

• If you can’t pay the debt as promised, then the lender may take your home or force a sale to cover the remaining debt.
• Filing for bankruptcy? Don’t count on this debt getting discharged. You’ll likely have to sell your home first.

Great when: You have a lot of equity in your home, your spending is under control, and you’re looking for a lower rate.

Credit Card Balance Transfer

What is it? The process of transferring high-interest debt from one or more credit cards to another card with a lower interest rate. Many credit cards offer a 0% introductory APR for a certain period of time, typically 12-18 months.

Benefits of credit card balance transfers:

• You can focus on paying one credit card as opposed to managing many.
• A 0% introductory APR can temporarily stop interest charges as you work to pay down your balance.
• The debt is unsecured so there’s no risk of losing an asset if you can’t pay off your balance as agreed.

Drawbacks of credit card balance transfers:

• It’s another credit card. There’s an opportunity to build more debt with this new line of credit...with great power comes great responsibility.
• Credit card companies are nice for giving you the 0% introductory period but they may get money in other ways. Be sure to check for fees on balance transfers before making a move.
• Just because you apply for a credit card doesn’t mean you’ll receive a credit limit high enough for all of your debt. If you find yourself in this situation, then it may be worth calling the company to negotiate a credit line increase or at least transferring your highest interest debt.

Great when: You have good credit, your spending is under control, and you’re able to pay off the balance within the introductory period. Don’t use this as a way to delay the inevitable.

Next Steps

Debt consolidation can really simplify your financial situation, but it’s not a simple decision. If you’re looking for additional advice, we’re here to help.

First, be sure you’ve created your debt reduction goal in BrightPlan. The debt reduction goal gives you a plan to become debt free and helps you stay motivated by tracking your loan balances over time.

If you’d like to talk with a money expert about your debt, schedule a call with a financial advisor from Plancorp. They can answer your questions about the benefits and drawbacks of debt consolidation, and help you discern if this is a tool you should use in your debt reduction strategy.