Debt can feel overwhelming for anyone, but if you have bad credit, tackling it can seem nearly impossible. Keeping track of what you owe, finding the cash to cover your bills and making payments to a half-dozen creditors as you rack up interest each month may be discouraging, but there are options to help you through. Debt consolidation loans is an option when dealing with bad credit but are they the best choice?
Handling debt with bad credit – consider debt consolidation
If you have a bunch of outstanding bills with different minimum payments, penalties, and due dates, debt consolidation is one way to get organized and perhaps even reduce the interest you pay over time.
A debt consolidation loan may allow you to roll all your monthly bills into one payment. Not only does this simplify your finances, but it may qualify you for a lower interest rate than you have on one or more credit cards, which can save you money as you pay down your debt.
The most recent consumer credit data from the Federal Reserve found that the average credit card interest rate in May 2018 was 14.4%, while interest rates on 24-month personal loans averaged 10.31%.
Consolidation loans — unsecured personal loans are the most common type — are a more viable option than balance transfer cards for those with lower credit scores due to being able to qualify. To qualify for a balance transfer credit card it’s best to have a credit score in the 700’s or higher.
Debt consolidation loans, on the other hand, can still be had with a bad credit score (580 or below). If you are able to secure a debt consolidation loan for bad credit, you’ll probably be dealing with fairly high interest rates. Before committing to a loan make sure you’ve budgeting so you don’t fall behind on your loan payments.
It’s best to compare loans regardless of your credit score to secure one with the best rates. Companies like LendingTree, the parent company to MagnifyMoney, allows those with a minimum of 500 credit score to compare up to five lenders to find the best option even when dealing with bad credit.
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Compare Debt Consolidation Loans for Bad Credit
Is a debt consolidation loan a good idea for people with bad credit?
For borrowers without solid credit histories, a debt consolidation loan can be an option — but one that they should carefully weigh. Jonathan McAlister, a certified financial planner at Legacy Wealth Management in Memphis, Tennessee, said debt consolidation loans can help those with bad credit reduce their interest rates, pay down bills more quickly and keep better track of monthly obligations.
“However, it could have an unintended downside if the debt came from overspending and now the consolidation loan is being used to free up cash flow to continue an overspending habit,” he said.
Here’s a closer look at the pros and cons of getting a consolidation loan when you have poor credit.
- It’s easy to shop around for debt consolidation loans. Many lenders allow you to pre-apply, telling you if you’re likely to get approved for a loan and what interest rates you could get. This lets you quickly zero in on the best lenders to work with.
- You can combine different debt accounts into a single installment loan. The loan will have a single monthly payment that will be the same each month, making it easier to budget around it.
- A debt consolidation loan could give you a chance to lower your interest costs. This is especially true if you’re facing expensive debt such as payday loans or credit card balances, as these types of debt typically have higher rates than what lenders charge on debt consolidation loans.
- You have a clear path to getting out of debt. You can even choose a shorter loan term to get out of debt faster and pay less interest. Consolidating debt and repaying it responsibly can help you build credit. Using this loan to pay off credit card balances could lower credit utilization ratios. Adding an installment loan could also improve your credit mix, which could boost your score.
- Getting approved for a debt consolidation loan can be tricky when you have bad credit. You might have to spend more time looking for a lender that will work with you or even add a cosigner to qualify for a loan.
- Your new loan’s payments could be higher than previous minimum payments on credit card balances or other debt. If monthly costs are a concern, a longer loan term could be a wise choice — though it will increase what you pay over the life of the loan.
- With bad credit, you won’t qualify for the lowest debt consolidation loan rates out there. Some lenders will also charge origination fees to set up a loan, which could add to what you pay. Compare all options to make sure you don’t wind up paying more.
- A shorter term will get you out of debt faster, but you’ll need to pay more each month to make this happen. Check monthly payment estimates to be sure you can afford to do so. Some consumers might see their credit score temporarily dip after taking out a consolidation loan, McAlister said. You’ll also need to stay on top of your bills and always make on-time payments to avoid damaging your credit.
6 alternatives to debt consolidation loans for bad credit
1. Debt management plans
If you’ve already tried to manage your debt yourself with little success, or if you aren’t sure where to start, a debt management plan may be a good option. In a debt management program, you consolidate your payments through a nonprofit credit counseling agency, which in turn negotiates interest rates and fees with your creditors. Your debt stays with the original lenders, and the agency takes your single monthly payment and distributes it.
- You’ll make one payment each month rather than multiple to several creditors, which can simplify your debt.
- You get help negotiating interest rates and fees down, so your debt is costing you less.
- Ideally, you’ll pay your principal down more quickly and save on interest over time thanks to negotiated rates.
- Debt management programs aren’t free — expect to pay an enrollment fee between $25 and $35, plus a monthly cost in that same range. If you don’t have the cash flow to make minimum monthly payments on your outstanding bills plus these fees, debt management likely won’t be a good fit.
- You can’t use debt management to consolidate secured loans such as an auto loan or a savings-secured loan.
2. Home equity loan
A home equity loan is a type of secured loan in which you receive a lump-sum payment in exchange for putting up your home as collateral, which the lender uses to guarantee that it’ll get its money back if you don’t pay. As a result, lenders are often more willing to work with those who have less-than-excellent credit and to offer lower interest rates than you might get on an unsecured loan.
Here’s what you should know about consolidating debt with a home equity loan.
- You can get approved for a home equity loan even with bad credit. The loan is secured by the home, which lowers the lender’s potential risk and can make it likely to accept applicants with poor credit.
- Home equity loans traditionally offer lower interest rates than unsecured loans. This can make a home equity loan a more effective way to consolidate debt in a way that lowers your costs.
- Ideally, you’ll pay your principal down more quickly and save on interest over time thanks to negotiated rates.
- If you don’t own a home, a home equity loan won’t be an option — and if you do, you must have enough equity built up to qualify.
- The lender can foreclose on your home if you default. If you already have poor credit and struggle to make payments on existing credit lines, a loan that puts your home at risk could add to your debt woes.
- Home equity loans can have more upfront costs than personal loans, such as application fees, appraisal fees, brokers fees, and closing costs.
3. Home equity line of credit
Like a home equity loan, a home equity line of credit (HELOC) is secured by your property. But instead of a fixed-rate loan you pay back over time, a HELOC is a revolving credit line similar to a credit card — you pay interest at variable rates, but only on what you draw. In general, your “draw period” lasts between five and 10 years.
- You can borrow up to the credit limit on your HELOC, giving you more flexibility in how much and when you borrow.
- A HELOC has similar qualification requirements as a home equity loan — and similar limitations. It might be easier to get a HELOC with bad credit than, say, a personal loan.
- You’ll face lower closing costs on a HELOC than you would on a home equity loan. Some HELOCs even have discounted introductory rates that you can take advantage of to pay off debt faster.
- HELOCs often have a minimum draw or an amount you must borrow. If you don’t borrow at least that much you could face a fee.
- Similar to credit cards, HELOCs have variable rates that can rise if market interest rates go up, meaning you could end up with a higher rate later.
- If you don’t own a home, don’t have much equity built up or have a limited or difficult credit history, lenders are less likely to take that risk. Not paying off your HELOC balance can also put your home at risk of foreclosure.
4. Cash-out refinance
A cash-out refinance is a third way to leverage the equity in your home in which you apply for a new mortgage that exceeds the amount of your existing loan and receive the additional amount in cash.
- Unlike a home equity loan, a cash-out refinance is a first mortgage, so interest rates may be more favorable and poor credit less of a limitation.
- A cash-out refinance can also be used to lower your current interest rate or improve the terms of your mortgage, such as switching from an adjustable rate to a fixed rate.
- You’ll need to have equity in your home to benefit from a cash-out refinance. You’ll also need to maintain a loan-to-home-value ratio under 85%.
- As with a home equity loan, a cash-out refinance can bring in several fees and closing costs. This can add to what you owe or offset savings from a lower interest rate.
- This option will likely lengthen your mortgage, keeping you in debt longer and increasing the interest you pay on your home.
5. Negotiating a debt settlement
Debt settlement sounds similar to debt management, but they are not equal. For-profit debt settlement companies help you negotiate and settle debt in collections using payment plans or a dedicated savings account.
Alternatively, some creditors may be willing to negotiate with you directly. If you have outstanding medical bills with a hospital or a physician’s office, for example, you may be able to reduce or even eliminate your debt. It doesn’t hurt to call your creditors to ask about your options.
- Successful debt negotiation can help you eliminate debt for much less than you owe.
- If you can settle a debt, doing so can help you get rid of unaffordable debt and avoid bankruptcy.
- Most debt settlement companies will charge you a fee to negotiate debt on your behalf, but can’t guarantee a beneficial outcome. These can vary widely, so compare different services so you don’t end up overpaying.
- Watch out for debt relief scams: If a company asks for fees upfront, makes any promises or pushes you to sign up for services, avoid it.
Bankruptcy is a debt relief option that can help you discharge your debt and start with a clean slate.
Under Chapter 7 bankruptcy, also known as liquidation bankruptcy, a trustee will sell off some of your unprotected assets to partially repay your creditors. The court will then discharge your remaining debt.
- Bankruptcy will discharge many of your debts, providing relief if you’ve accrued more debt than you can realistically repay.
- Filing for bankruptcy will immediately bar lenders and collection agencies from pursuing payment from you.
- You can keep certain assets through a bankruptcy, including retirement accounts, your home, and other essential personal property.
- Declaring bankruptcy will significantly lower your credit score and make borrowing difficult. A bankruptcy can be listed on your credit reports for up to 10 years. However, the impact lessens over time and the process can help you move on from your debt more quickly.
- You’ll lose some of your property, which will be resold to satisfy your outstanding debts.
- Some debt and financial obligations are very difficult to wipe out in bankruptcy, such as student loans or back taxes.
To qualify for Chapter 7 bankruptcy, you must also undergo a means test. If your income exceeds the threshold, you might be eligible for Chapter 13 bankruptcy. In this scenario, you get to keep your assets but will be required to repay your debt over three to five years.
What option should I use?
Debt consolidation loans are a good option but aren’t the be-all and end-all for those with bad credit. Before you commit to anything, determine what you’re eligible for, weigh all your options and calculate how much each will cost over time. And don’t be afraid to ask for assistance.
“Consumers should always approach debt with a plan to pay it off,” McAlister said. “Seek professional help from a financial planner if you feel in over your head.”
This article contains links to LendingTree, which owns MagnifyMoney.
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