If you’re struggling with debt, you are not alone — the average American carries about $15,355 on their credit card, according to NerdWallet. There are two words you hear repeatedly as a possible solution: debt consolidation. Even so, when it comes to the process, you might be confused where to start. Here’s a primer:
First, what is debt consolidation? Consolidating your debt means you put it all together to refinance it. Let’s say you owe money on three credit cards. Each charges you on a different payment schedule and at different interest rates — a fairly complicated process to manage. With debt consolidation, you can change your terms and schedules by putting the debt in one place so you have only one monthly payment at a new (often lower) interest rate. This can make life a lot easier.
To decide if debt consolidation is right for you, ask yourself these questions:
- Do you have a lot of unsecured debt? Unsecured debt is any debt that does not have physical property as collateral against it, like your credit card bills. If yes, then consolidation is a good option. Don’t consolidate against secured debt, like your home, or you may end up losing it if you miss payments.
- What are the APRs on your credit cards? The average credit card rate can range from 16 to 19 percent, but when you don’t pay your minimums, this range jumps to 23 to 29 percent. If you are in the latter range, you should look to consolidate, as you will likely get a better rate.
- Do you have good credit? Your credit score will dictate how low a rate you can get. If you have a credit score of 640 and above, online marketplace lenders such as Prosper could be a great option. This increasingly popular financial service makes it easy for borrowers to consolidate high-interest debt.
If you want to explore consolidating your debt, here is what to do next.
- Set up a counseling session. A credit counselor (such as SavvyMoney) can help you look at your finances holistically and identify the best avenue to reach your debt-free goals.
- Do the math: Let’s say you put a $10,000 medical expense on your credit card. According to Bankrate.com, if you just pay the minimum each month, it will take 28 years to pay off your debt, and you will end up spending more than $12,000 in additional interest payments.1 Compare that to an option such as marketplace lending, where you can pay off your debt in three years with a fraction of the interest payments — savings could amount to more than $11,000.2
- Research a good credit agency. Many agencies have high service fees and interest rates that are very comparable to other creditors, so do your homework. Look for an agency that belongs to either the National Foundation for Credit Counseling or the Financial Counseling Association of America.
- Know that your work isn’t done. Refinancing your debt is only the first step. As you would with a credit card company, make sure to stick to your plan to make timely, regular payments over the course of your loan term.
Congratulations. You’ve taken the first step of educating yourself about your options. With the right partner and some reorganization, you will be on your way to financial well-being. For inspiration, check out these stories of people who successfully navigated this journey.
1According to the Bankrate.com Minimum Payment Calculator. This estimate assumes a 16.00% interest rate and a minimum monthly payment equal to 1% of the outstanding balance plus any new interest. Your actual minimum payment, payoff time, and payoff cost will depend on your account terms and any future account activity.
2This is based on a three year $10,000 loan with a Prosper Rating of AA and a rate of 5.32 % (5.99% APR) would have 36 scheduled monthly payments of $302 resulting in total interest charges of $842. To qualify for an AA Prosper Rating, applicants must have excellent credit and meet other conditions. Between October 1, 2014 and September 30, 2015 the average three-year loan rate presented to other pre-approved applicants was 12.8% (16.0% APR).
Sarah Cain is a member of the DailyWorth Connect program. Read more about the program here.