The Pros and Cons of 8 Different Ways To Consolidate Debt

If you’re considering consolidating your debt, you should know the pros and cons of your options so you can make a financially wise choice. You don’t want to make a costly mistake that could put you further in debt.

by Gerri Detweiler

Next to winning the lottery, a debt consolidation loan is a debtor’s dream.

You’ll have one monthly payment and be able to pay off those bills finally.

In reality, consolidating bills isn’t always easy. Finding a consolidation loan at a decent interest rate can be challenging if you have a lot of debt. And if you’re not careful, you can end up deeper in debt than when you started.

Here are the pros and cons of some of the best ways to consolidate debt:

1. Using Credit Cards

If you have a card with enough available credit to cover the balance on another card, see if the first card has a balance transfer offer you can take advantage of. Or call your card issuer and ask them what rate they can give you to transfer balances from other cards. Aim for fixed rates and no transfer fees when possible. Alternatively, get a new balance transfer card.

Pros: Lower interest rates and no collateral.

Cons: May have hidden traps in low rates; requires decent credit rating.

2. Home Equity Loans or Lines of Credit

Get a low or no-cost loan tied to the equity in your home. In many cases, homeowners can borrow up to 80% to 95% of the value of their home, minus any first mortgage.

Pros: Lower interest rates and interest is usually tax-deductible.

Cons: Adjustable interest rates and interest-only loans may be somewhat risky. You can lose your home if you miss payments. Home equity rates are high right now (although much lower than credit card rates).

3. Cash-Out Refinance

Refinance your current mortgage, and if you have equity available, take “cash out” to pay off other debts.

Pros: Lower interest rates and the interest is usually tax-deductible.

Cons: Cost of refinancing may be 4% or more of the total loan amount; higher payments can put your home at risk. Not a good option when mortgage rates are high and your current rate is low.

4. Traditional Debt Consolidation Loans

Get an unsecured loan from a local bank or lender to pay off other debts.

Pros: No collateral or homeownership required.

Cons: Interest rates may be somewhat high, and it’s tough to find an affordable loan if you have much debt or a poor credit rating.

5. Counseling Agencies

Ask a non-profit counseling agency to help structure repayment plans with unsecured creditors. You make one monthly payment to the counseling agency, which pays participating creditors.

Pros: May offer lower interest with fees waived; can improve your credit if you stick with the program.

Cons: Not available for all types of debts. Must choose a reputable agency or risk late payment or other problems.

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6. Debt Negotiation or Settlement

Hire a settlement company to negotiate lump sum settlements on your debts, usually 50 to 60 cents on the dollar or less (including fees). The settlement comes from the monthly amount you pay to the settlement company after you stop paying your creditors.

Pros: End creditor harassment, avoid bankruptcy, and usually out of debt in 18 to 24 months.

Cons: Short-term damage to credit rating and some types of loans not eligible. Must choose a reputable agency.

7. Retirement Loans

Borrow against the money in your 401(k), 403(b), or pension plan, usually up to 50% of the balance.

Pros: Easy to get with no credit check or income qualifications. Low interest, paid to yourself.

Cons: May shortchange retirement by keeping it out of investments. May have to pay back debt if you leave your job before the loan is repaid.

8. Rapid Repayment

Create a rapid repayment schedule based on a mathematically optimal way to pay your debts. Pay the highest interest rate debt first, then move down the line. (See Debt Repayment Strategies: The Snowball vs. The Avalanche.)

Pros: Inexpensive, often gives consumers an alternative to debt consolidation.

Cons: May not offer enough relief if you have substantial debt. Need to update the plan as rates and terms on loans change.

Mistakes To Avoid

The biggest mistakes people make when it comes to consolidation are:

Not having a plan for paying the debt off after they’ve consolidated and
Procrastination. Waiting for the “perfect” solution to come along almost always means you’ll end up deeper in debt. Choose your approach, and start getting out of debt today!