What is Credit Consolidation, Anyway?

The average American household had about $8,109 in credit card debt toward the end of 2017. That means the U.S. is pushing 1 trillion dollars in credit card debt overall. And that’s just the tip of the iceberg. There are many other categories of debt to consider: student loans, medical bills, auto loans and more.

It can be very overwhelming to carry debt from multiple categories, or from multiple creditors. After a while, it starts to seem impossible to dig yourself out. Every time the phone rings, you cringe, knowing it’s likely a creditor on the line. That is—unless you have a plan.

Managing your debt

You may have heard about debt consolidation before and wondered how it works. Keep reading to learn more so you can make informed choices about your financial future.

Debt Consolidation with a Loan

It sounds counterintuitive to take out a loan to pay off your outstanding debts. However, this fixed-rate personal loan strategy could help declutter your debt outlook. For example, let’s say you have five separate credit cards with balances. Instead of trying to keep track of all this paperwork and stay on top of due dates, you would be making a single monthly payment on one loan. The obvious pros are that it’s more streamlined and predictable.

However, consumers should be aware that the interest rate on these loans can be high—although it may still be lower than your highest-interest credit cards. So, falling behind on these payments will be costly. It’s also important to avoid racking up any additional debt on your open credit cards, even after you’ve paid the balance back down to zero. Otherwise, you’ll have a loan to pay plus freshly accumulating debts.

In general, debt consolidation is an option for consumers with good credit, adequate cash flow and debt that’s less than half their income.

Debt Consolidation vs. Debt Settlement

You may be wondering how credit consolidation stacks up against a strategy like debt settlement. After all, they both simplify payments down to a single amount per month. However, they approach this goal differently, each with unique risks and benefits to consider.

Debt consolidation hinges on taking out one loan to pay back multiple debts. Consumers do assume some risks taking out this loan. Debt settlement, on the other hand, involves working with a company to negotiate your debts down. Consumers then put money into a single monthly account, which goes to creditors at a rate higher than the bare minimum. This provides a chance to settle debt faster without a loan. Then again, it could affect your credit.

Choosing the best strategy for resolving your debt is a matter of researching your options carefully. What works for one person may not work for another. Factors like your credit score and income do enter the equation, so it’s useful to audit your own finances before making a decision.

Cutting a credit card

Avoiding Further Debt Is Key

Let’s say you decide to pursue debt consolidation or settlement. You’ll be taking one step forward and two steps back if you start accumulating fresh debts while also trying to pay off your existing ones. This can become dangerous if you’re struggling to pay off a loan and credit card balances.

So, half the battle is finding ways to minimize or eliminate future debt. Best practices include:

  • Building up an emergency fund completely independent of your credit cards.

  • Charging only purchases you can afford within the month.

  • Creating an electronic budget to track spending and updating it regularly.

  • Steering clear of ‘tempting’ credit card offers while paying off your old ones.

Both debt settlement and debt consolidation, also known as credit consolidation, are a viable option for many consumers overwhelmed by debt from multiple sources. However, it’s wise to explore your options before committing to a particular debt management strategy. In the meantime, always work on your financial habits.