While a debt consolidation loan is an excellent tool to help you gain control over your debt, it might not be the perfect solution for everyone. Several alternatives to debt collection exist, and if you’re considering debt consolidation, you should know what these other options are, as well as the advantages and disadvantages of each debt management solution.
Credit Card Balance Transfers
Balance transfers are technically a form of debt consolidation. You're using another credit card with a much lower interest rate to pay off your existing credit card balances instead of using a term loan, such as personal loan.
A balance transfer can be beneficial, but you have to make sure you're not going to keep adding to your existing credit card balances. If you plan to keep using your high interest credit cards after you've transferred your balance, you might get yourself in more debt than before you made the balance transfer.
You should also make sure you can pay off the balance on your new credit card before any special introductory rates expire, and make sure you know the true interest rate you'll be paying once that occurs. The long-term rate should be lower than what you were paying on before you transferred your credit card balances.
Refinancing Your Debt
Debt consolidation and refinancing are very similar. In fact, debt consolidation is a form of refinancing! The big difference between the two is the number of loans you are refinancing.
With debt consolidation, you are combining several loans or debt obligations into one large one with better terms. Refinancing, on the other hand, involves paying off one loan with another loan that has better terms.
If you only have one or two debts you're trying to pay off, you might want to refinance those debts separately rather than get a debt consolidation loan. However, if you have more debts than that, you'll want to get a debt consolidation loan. You should also keep in mind that you can't refinance unsecured debts unless you have a debt consolidation loan.
Debt Management Plans
A debt management plan is a payment plan set up for you by a credit counseling agency that helps you repay your debts by negotiating with creditors. Often, these agencies can reduce or waive fees, finance charges and decrease interest rates to lower your monthly obligations to ensure repayment. However, you'll probably have to pay a monthly service charge to the credit counseling agency as well.
Debt management plans and debt consolidation loans offer similar advantages, such as:
- Only making one payment to one place
- Lowering your monthly payments
- Lowering your interest rates
- Paying off your debt faster
- Improving your credit score
- Stopping collection calls
However, a debt management plan will require you to close any credit card account in your debt management plan to ensure you aren't taking on more debt while you're trying to pay back what you owe. You'll also have to make regular payments to keep any of the benefits.
The biggest disadvantage, though, is that not all creditors participate in debt management plans. If you're considering using a debt management plan, you'll need to make sure your creditors are onboard.
One thing to keep in mind about debt management programs is that they can be a good alternative to debt consolidation loans if your credit score is below 620. This is the bare minimum score you need in order for many lenders to consider giving you a loan.
Debt Forgiveness Programs
Debt forgiveness is when your creditors agree to cancel some or all of your debts owed, usually through negotiations by a debt settlement company on your behalf. You have to owe a lot of debt in order for this to be an option, usually over $10,000, and you need to be over six months behind on unsecured debt payments, such as credit cards.
The main advantage of debt forgiveness is that you ultimately pay less money than you owe, so you feel like you are saving money. This is really enticing when you’re struggling to pay off large amounts of debt.
In reality, though, the cons of debt forgiveness typically far outweigh the potential savings. However, if your credit score is already below the 550 mark and you have the money to pay off the newly negotiated balance as a lump sum, debt forgiveness could be a reasonable solution to your debt problems.
While debt consolidation may not be the perfect option for everyone, debt forgiveness is rarely an appropriate solution to your debt issues. Debt forgiveness can seem like a great option in theory, but in practice it is often full of more struggles long term, the least of which is a destroyed credit score.
The debt forgiveness industry is also wrought with scams and is poorly regulated. Debt consolidation on the other hand, is a common type of loan that is relatively easy to obtain from reliable financial institutions.
Bankruptcy is the legal process that declares your debts as discharged and stops your creditors from being able to make further attempts to collect them. While there are several types of bankruptcy, the two most common forms are Chapter 7 bankruptcy and Chapter 13 bankruptcy.
In a Chapter 7 bankruptcy, also called a liquidation bankruptcy, you’ll have to sell off your assets and property to pay off everything you can to your creditors. This is what most people think of when they refer to filing for bankruptcy.
In a Chapter 13 bankruptcy, on the other hand, a credit counseling service will work with you to develop an aggressive payment plan for you to repay your creditors, usually in 3-5 years. This process is known as debt restructuring.
Bankruptcy has several advantages:
- It gives you a clean starting point to get your finances back on track.
- It stops your creditors from contacting you for payment.
- It’s easier to explain to future lenders than continually having to explain missed and late payments.
- It provides relief from unmanageable levels of debt.
However, bankruptcy also comes with severe disadvantages.
- You will lose most of your possessions and your current lifestyle
- The courts will make your name and financial status public.
- You'll also be required to close any credit card accounts you have.
- Some debts, like student loans and taxes, cannot be discharged.
The biggest disadvantage, though, is that filing for bankruptcy will negatively effect your credit score for up to ten years. Given how important your credit score is in your day-to-day life, this could impact what kind of loans you can get, where you live and even whether or not you can get a job.
Bankruptcy should be your very last recourse for dealing with debt. It is not something to go into blindly or because you want a quick fix to your debt problems. It is a legal process that can take years to work through and recover from.
Get Help Managing Your Debts at First Alliance Credit Union
Debt consolidation loans are a great way to get your debt under control, but they aren't the only way. Several other methods exist, all of which have their own advantages and disadvantages, and may be a better fit for your current financial situation than debt consolidation.
If you need help figuring out which way would work best for you, contact First Alliance Credit Union today. Our knowledgeable lending advisors will talk with you about the pros and cons to make sure you get a financial solution that works best for you. We also now offer virtual meetings for your increased convenience and safety.
If you'd like to get more information about whether debt consolidation can help you, download our free debt consolidation calculator. It's easy to use and can help you see the benefits of debt consolidation for your specific financial situation.