3 ways to consolidate debt and start rebuilding credit
By Erica Sandberg
October 27, 2015
I have five credit cards all with high balances and two that are in collection. I want to do a debt consolidation to pay and clean up my credit. Who do I go to? — James
Here's a closer look at the three debt consolidation options:
1. Bank consolidation loan: With a debt consolidation loan, the bank takes on debt you've acquired from other sources and repackages it into a new loan.
When these loans work, they work well. You don't have to deal with different statements with varying due dates. And if the loan has a lower interest rate than the combined debts, you would come out ahead financially, as the total fees would be less than what you're paying now.
However, there are a couple of problems with consolidation loans. The first is that you would need a good credit rating for the bank to find you to be worth the loan risk. Those two accounts in collection probably would be held against you. A bank wants to be as certain as possible that the borrower will repay according to the terms of the agreement.
2. Credit counseling agency program: Nonprofit organizations also have debt consolidation programs, but these are not loans. Rather, these organizations are third-party agencies that manage a person's credit card bills. You make one payment to the agency, which distributes the money to your credit card companies. Many creditors agree to lower the interest rate to those on a debt consolidation program, so the fees would be reduced. These debt consolidation plans are arranged so you would be out of debt in a maximum of five years.
Sound good? It can be, but a debt consolidation plan run by a credit counseling agency has to be right for you. If you don't have enough income to meet your basic expenses — plus some extra for savings as well as the debt payment — this consolidation plan won't be offered. If a consolidation plan is offered, you would have to close all of your accounts but one and not open more so you can concentrate on repaying the debts. Not everyone likes this requirement.
Finally, the collection accounts would be your responsibility. Companies that sent accounts to collections rarely work with credit counseling agencies, as they don't want a debt to be extended for years.
3. Do-it-yourself plan: That leaves one other way to consolidate your debts, and that's a DIY plan. If any of your creditors have a balance transfer option, think about using it to shift some (or all, if possible) of your higher rate credit card accounts to that card. The fewer accounts you have to manage, the more streamlined your financial affairs will be. And you'll likely win with a balance transfer card, as these cards often have a very low interest rate or even no interest for the promotional period.
The problem? You have to qualify for a balance transfer, and you may not if your credit rating is too low. Even if you can get a balance transfer with a lower interest rate, you'll have to make sure you repay the rolled-over balances by the deadline. If you don't, a potentially high interest rate will kick in. In most cases there also is a transfer fee — usually 3 percent of the amount transferred — which is added to the debt.
The issuer of your balance transfer card won't absorb accounts in collections, so you'll have to deal with those on your own. If these accounts went to collections recently, they are bottoming out your credit score, so erase them with cash on hand, by selling assets or by starting to save to pay them off. Many collectors will accept a settlement, which is a cut of the debt, but that's something you'll have to negotiate independently.
Don't worry if none of these options is available to you. You can take steps now to pay down your debts. Just pay the most to the creditor with the highest interest rate, and pay the minimum to the others. When that high interest account is at zero, add more to the next most expensive debt. This will be more laborious than managing one account through a debt consolidation, but eventually you'll get to a single account. And all the while you will be rebuilding your credit.
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