Best Way to Consolidate Debt


Consolidating debt means taking a whole bunch of debts from different sources and transferring it into one loan. Some people consolidate debt to lower their monthly payments. That can end up costing more over the long run because it stretches out the time it takes to pay off the total debt, and can result in more interest payments. Consolidating debt at lower interest rates should be the goal.

Consolidate Debt Using Home Equity

One method of consolidating debt is to tap into the equity of your home. You can consolidate debt by taking out a second mortgage on your house, or taking out a home equity line of credit, and using that money to pay off other creditors. Because mortgages and home equity lines of credit generally have lower interest rates than credit cards, that approach can save a lot of money. In addition, mortgage interest is often tax deductible, so the savings may be even greater. However, there are significant risks associated with this course of action. Credit card debt is unsecured debt, which means if you can't pay, creditors can't just seize assets. Mortgage debt, however, is secured by your house. If you are unable to pay your mortgage debt, you may lose your home, while inability to pay your credit card debt does not usually result in this.

Consolidate Debt Using Credit Card Balance Transfers

Using credit card balance transfers can be an effective way of consolidating small debts. Credit card companies routinely offer promotional rates to people with decent to good credit. Those rates range from no interest for six months to a year, to a low percentage rate (1.99 percent to 5.99 percent) for a set period of time or for the life of the balance (the amount of time it takes you to pay off the debt). There is usually a fee associated with balance transfers, which is generally about 3 percent of the total debt, and the fee is usually capped at a maximum amount. You must qualify for a line of credit in order to transfer a balance, and you can transfer a balance up to the amount you qualify for. When you transfer a balance to a credit card, it is important to note how long you have to pay off the balance before the interest rate becomes higher. You should also avoid using the credit card for standard purchases, because generally payments are applied to lower interest rate debt first (as of August 2009, although the laws may be changing regarding this practice).

Consolidating Debt Using a Personal Loan

Personal loans, obtained from a bank or credit union, are a third option for consolidating debt. This involves using the cash from that loan to pay off your other debts. Interest rates on personal loans are usually higher than the promotional offers offered by creditors, but the interest rate is locked in for the life of the loan.

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