8 myths about debt consolidation debunked
Do you really understand what it means to consolidate your debts? We debunk some of the most common misconceptions.
If you’re repaying multiple debts — whether personal loans or credit cards — you might be considering debt consolidation. With so many options under the umbrella of debt consolidation, understanding what it means can be complicated.
We clear up eight common misconceptions about minimizing and simplifying your debt.
False. Debt settlement is a bankruptcy alternative, where you negotiate with your creditors to reduce the amount you owe in exchange for a one-time payment — typically a percentage of your outstanding balance. You can negotiate with your creditors yourself or through a company specializing in negotiating debt. If you go through a company, it pays off this negotiated amount on your behalf, and then you repay the agency through monthly payments over a period of usually three to five years.
Debt settlement is risky: It could expose you to a lawsuit if your creditors don’t want to wait through negotiation, and there’s no guarantee it will work, making it an even riskier move. However, bankruptcy is a drastic option that can hurt your credit score and haunt your credit report for years to come.
Learn more about the differences between debt settlement and bankruptcy in the table below.
False. You can generally transfer personal loans, though not with every credit card provider. Balance transfer credit cards are typically used for transferring debts between credit cards. However, it is possible to find providers willing to allow you to transfer debt from a personal loan — which can be a smart move if you’re looking for an interest-free or low interest way to pay down smaller debts for up to 12 months.
False. You’re able to access other lines of credit, even if you’re settling debt with a specific creditor.
To avoid falling further into debt, stick to a budget and keep from applying for credit you can’t afford. If you’re not able to keep up with payments, your creditors could take you to court.
False. Debt consolidation can be a good way to reduce what you’re paying in interest and fees, making it easier to manage your repayments. However, if you’re still swiping for purchases on a card you’re paying down or fail to chip away at your debts during a balance transfer card’s low or zero interest promo period, you could be right back to collecting interest.
False. You’ll find several different types of debt consolidation loans and credit accounts out there. Some are marketed as “debt consolidation loans,” while others are simply well suited for consolidating what you owe.
Here are the main types of debt consolidation:
- Debt consolidation loan. These loans are specifically designed to help you consolidate existing debt. Ideally, a lender offers lower rates or better terms than you currently have. If you’re approved, the lender usually pays your existing debt on your behalf, and then you pay the lender monthly.
- Unsecured personal loan. An unsecured personal loan can help you pay down your outstanding debt on your own. However, approval for the entire amount you need to repay isn’t guaranteed.
- Home equity loan. If you own property and have outstanding personal loans or credit card debt, consider a low-interest equity loan, where you can use your home as collateral to consolidate your debt. Keep in mind this is risky since you could stand to lose your home if you fail to repay.
- Balance transfer credit card. While not technically a loan, balance transfer credit cards are a way to consolidate debt from separate accounts onto one card and pay it back over a low or zero interest period.
False. It’s a common misconception that debt consolidation instantly saves you hundreds, or even thousands of dollars. It could, but you’ll want to watch out for loans that charge early repayment fees and penalties.
To make sure debt consolidation works for you, first calculate how much you’re paying across all of your loans or cards each month. Then, check the terms of each loan contract to see how much it might cost for you to close your accounts and pay early. That way, you can decide if any upfront costs are worth the savings in the long term.
True, but only temporarily. Whether debt consolidation knocks down your score depends largely on the method you choose. For example, taking out a personal loan could affect your credit score differently than a balance transfer credit card will.
Even so, any dip in your credit score due to inquiries is only temporary. If you stick to a budget when tackling your debt, you’ll have a better chance of getting out of debt while saving a few dollars. Taking care of debt in the present can prevent it from affecting your future.
False. Credit counselling is just what it sounds like: counselling. Both terms can come up in the same conversation or search, but credit counselling generally precedes debt consolidation, because it’s truly only advice and tips on how to successfully manage your money and debt.
Before you apply for a debt consolidation loan or settlement program, compare your debt solution options to make the right decision for your personal circumstances.