Being burdened with debt can be stressful. It’s even worse to be weighed down by debt when you have to keep track of multiple credit agreements, creditors, and payment plans.
But this is the reality for many borrowers. Earlier this year, credit reporting agency Experian reported that in 2023, Americans were saddled with average debt balances of approximately $24,000 on auto loans, $19,400 on personal loans and $6,500 on credit cards, not to mention more large balances on student loans and mortgages. Overall, household debt is at an all-time high—and if you’re one of the many people who owe, you’d probably welcome lower interest rates and the ability to make one monthly payment instead of several.
Debt consolidation can help you do this. This strategy essentially replaces your multiple debts with one new loan, which ideally has a lower interest rate. If you’re on a budget, consolidation can help you lower your monthly debt payment to free up some money to pay other bills. On the other hand, if you can get a higher interest rate and still pay the same—or more—each month on your debt, consolidating your debt could be your path to a faster repayment date.
Here’s an overview of three debt consolidation loan options—and who should consider each.
1. Home Equity Line of Credit (HELOC) or Home Equity Loan.
Best for: Homeowners who have significant equity in their home and are willing to take on the risk of using their home as collateral.
More details: Rising home values may be bad news for potential buyers, but it also brings good news for homeowners: They have record-high home equity, giving them attractive lending options in the form of a home equity loan and line of credit, or HELOC. .
These loans allow you to borrow against your home even as you pay off your mortgage. Home equity loans provide a lump sum of cash, while a line of credit gives you a borrowing limit that you can use over several years.
“The advantage of borrowing through either a home equity loan or a HELOC is that since it is a loan using your home as collateral, you can get interest rates that are lower compared to unsecured borrowing options such as credit cards or signatures. loans,” says Bruce McClary, senior vice president of membership and media relations for the National Foundation for Credit Counseling.
Interest rates currently start at around 8%, although your rate will depend on factors such as your lender, the value of the home and your credit history. However, there are serious risks that should be considered.
“The downside is that you’re putting your home on the line, and if you have trouble paying off the debt and if the loans go into default, you could be facing foreclosure,” McClary says.
Exact qualification requirements will vary by lender. But the general rule of thumb is that you should have at least 15-20% equity in your home, your credit score should be at least 620 (though many lenders require a higher score), and your debt-to-income ratio should be yours. monthly debt payments compared to your monthly income – should not be higher than 43%.
If you can get a lower interest rate than you are paying on other debt, this may be a good route to take. But don’t forget to factor in any closing costs, which vary by lender but can include loan origination fees, appraisal fees and more.
2. Credit card for balance transfer
Best for: Borrowers with smaller balances who can pay off their debt during the 0% interest rate period.
More details: Credit cards are known for their high interest rates. Annual Percentage Rates (APR) typically exceed 20%, and some cards have top rates approaching 30%.
“If you have a large balance on a high-interest card, you’ll need giant payments to make any progress,” says Glenn Downing, founder and principal of investment advisory firm CameronDowning. But balance transfer credit cards give you some relief because they come with introductory or promotional rates—even 0%. The idea is that you can transfer your current debts to the new card and pay off the new balance before the 0% APR period ends.
Who wouldn’t say yes to cutting interest payments, right? The catch is that after the promotional period, you’re subject to standard credit card terms, which means the sky-high interest rate may return.
“Carry over what you think you can pay off and get to a zero balance within the specified time period,” Downing says.
Balance transfers typically incur a fee of between 3% and 5% of your total balance, so keep in mind that you’re initially going to increase your debt. Additionally, credit cards usually have credit limits, and you won’t be able to transfer more than that limit allows. Lastly, issuers of these cards typically require borrowers to have a credit score of at least 670 (the higher the score, the better your chances of getting one of these cards).
To make sure you don’t get stuck in a cycle of credit card debt, you should first calculate how much you’ll have to pay each month to pay off the balance before the promotional period ends. Then you’ll want to stick with this payment plan. And be disciplined and don’t accumulate new debt on this card after paying off the balance.
According to McClary, “This is where the stars have to align if you want to achieve the best results.” But if you shop around and find a 12 to 18 month interest-free card, it might be worth it.
3. Consumer loan
Best for: People who don’t own a home (or don’t want to use their home equity) and have at least a fair credit score.
More details: Another way to eliminate your various monthly debt payments and replace them with one loan that you can easily keep track of is a debt consolidation loan, which is a type of personal loan. Banks, credit unions and online lenders will provide you with money to pay off existing loans, often at a lower interest rate than you’re used to. In fact, the consumer loan business is booming, in part because Americans are looking for debt consolidation loans.
Interest rates on these loans can vary widely depending on your credit score (lenders typically want to see at least 580) and your overall financial ability to repay them. While you may qualify for a loan with bad credit, the interest rate may not be worth it. If you have excellent credit, you may be able to get a rate on the lower end of the spectrum, with rates currently starting at around 9%. But if you don’t have a good credit rating, you may be offered a rate similar to what you pay on your credit card; Some lenders have a maximum annual interest rate of up to 35%.
Generally speaking, people with higher credit scores will likely get a lower rate than on a credit card, but not as low as with a HELOC.
“There is no collateral, so the lender will likely manage its risk by offering you a higher interest rate than it would otherwise provide on a secured loan,” explains McClary.
The APR on a personal loan typically includes an origination fee, and it can be high—sometimes up to 12% of the total loan amount—so you’ll need to crunch the numbers to make sure the switch is worth it. Finally, if you’re used to paying only the minimum amount on your credit card, it’s important to make sure you can make your monthly payments on your personal loan. As with other loans, missing them can mean late fees, damage to your credit report and, ultimately, phone calls from debt collectors.
More money:
6 Tips to Make Debt Consolidation Work for You
A Four-Step Guide to Resolving Credit Card Debt
Debt Snowball or Debt Avalanche: Which Payoff Strategy is Right for You?