Debt consolidation loans are an excellent financial tool that can help you pay off your debts, decrease your total monthly payments, and accelerate your journey to financial freedom.
That said, if you have taken on debt with multiple lenders, accumulated high loan amounts, and are behind on payments, your credit may not be in the best shape. The good news is that plenty of lenders offer debt consolidation loans for bad credit.
If you have been searching for a way to alleviate your financial challenges, you may want to dive deeper into how to qualify for a debt consolidation loan with bad credit. There are pros and cons of debt consolidation, and there are some alternatives you may want to explore as well.
What is Debt Consolidation?
Debt consolidation is the process of combining multiple loans into a single debt and monthly payment. There are two goals behind debt consolidation — to reduce your cumulative monthly payments and reduce the interest rate on your debt. Ideally, you want to save at least a couple hundred dollars per month and have a loan term between 36-60 months (3-5 years).
By reducing your monthly payments and decreasing your repayment term, you can save thousands in interest charges. Additionally, a debt consolidation loan can give you the financial flexibility needed to save money, build an emergency fund, and pay off other debts, such as your car loan.
Traditionally, you consolidate debt by borrowing a large lump sum and paying off several of your other obligations. For instance, say you have three credit cards, each with an interest rate above 15%. Cumulatively, your cards have a balance of $10,000.
In this scenario, you could take out a $10,000 debt consolidation loan (with a lower interest rate and set repayment term) and pay off all three cards. Instead of making three separate payments at a high-interest rate, you could pay one lender and save money.
Benefits of Debt Consolidation
By consolidating your debt, you can:
1. Wipe Out Credit Card Debt
Technically speaking, you are just moving debt from your credit card to a personal loan. However, your credit report will still reflect that your credit card utilization rate has dropped once you consolidate your debt. As a result, your credit score might get a boost.
Additionally, reducing your interest rate and combining your debt into one loan will help you pay off your bills faster. You can put extra money toward your loan, make principal-only payments, and save thousands in interest.
2. Lower Your Interest Rate
Speaking of interest, one of the biggest perks to debt consolidation is that personal loans often have much lower interest rates than credit cards. That said, if you are getting a debt consolidation loan with bad credit, your rate may not be as good as you would like, especially if you are taking out an unsecured loan. An unsecured loan is any loan that is not backed by real property, such as a vehicle or home.
Now for the good news. If you take out a secured loan and use a paid-for vehicle or the equity in your home as collateral, you may be able to get a much better interest rate. Before settling on a particular loan type, make sure to compare your options to determine which approach makes the most financial sense for you.
3. Consolidate Your Payments
Keeping up with multiple credit card or loan payments can be tedious. Consolidating your debt can simplify your budgeting process and help you maintain better control of your finances. When you have fewer recurring bills, it is easier to manage your money and set financial goals.
To maximize the benefits of your debt consolidation loan, ensure you have enough cash to completely pay off several bills. Partially paying down a few bills won’t provide much benefit and can actually make your financial situation more complicated.
4. Save Money
The key benefit of taking out a consolidation loan with bad credit is that doing so helps you save money. Depending on what bills you pay off and how low your interest rate is, you may save several hundred dollars per month. Additionally, you will save thousands in interest over the life of your loan.
While spending your extra cash may be tempting, make sure you allocate at least some of it to an emergency fund. Building a healthy emergency fund that can cover three to six months of your basic life expenses will help you stay out of debt once you pay off your loan.
Risks of Debt Consolidation
Debt consolidation loans are a great tool for saving money, reducing your interest rate, and getting out of a financial bind. However, taking out a debt consolidation loan with bad credit does involve some risks. As you explore debt consolidation, be wary of the following:
Some lenders charge high balance transfer or origination fees when issuing debt consolidation loans for bad credit. With that in mind, make sure to ask plenty of questions before taking out a loan, including what sort of fees you will be charged.
If you are receiving your loan in a lump sum payment, find out what percentage of the borrowed amount you will actually receive. For instance, if you borrow $10,000 to pay off three credit cards and the lender charges an 8% origination fee, you will only receive $9,200.
The Temptation to Spend
Seeing the balance on your credit cards hit zero may spark your urge to spend. Whatever you do, resist this temptation. If you rack up huge credit card bills again, you will have hundreds in monthly payments plus your new debt consolidation loan.
Once you pay off your credit cards, consider locking them so that you cannot use them for casual purposes. Also, revisit your monthly budget and identify any ways to save. Making a few small tweaks to your budget can help you achieve financial freedom and build your emergency fund.
Further Credit Score Damage
Any form of formal borrowing, including a debt consolidation loan, will drop your credit score by a few points. This drop occurs when the lender conducts a hard inquiry to obtain your credit report. You should rebound from this damage within a few months as long as you make your payments on time.
However, if you use a credit card to consolidate your debt as opposed to a personal loan, your credit utilization rate will go up. In turn, this can significantly drop your credit score.
The Possibility of Losing Collateral
Using collateral to obtain a lower-interest-rate debt consolidation loan is a great strategy for maximizing your savings. However, if you fail to pay back your loan, the lender will assume ownership of the collateral.
Therefore, you should only take on a secured debt consolidation loan if you are confident in your ability to repay it.
How to Qualify for a Debt Consolidation Loan with Bad Credit
If you want to qualify for a debt consolidation loan with bad credit, focus on the following:
- Getting your credit score above 670 (if possible)
- Making payments on time
- Ensuring you have sufficient income (At least $35K per year in most cases)
- Decreasing your debt-to-income (DTI) ratio
If your credit score is poor and you can’t lower your DTI, consider putting up some collateral. Securing funds with a car or your home equity makes lenders less apprehensive when dealing with individuals with bad credit.
How to Find the Best Debt Consolidation Loan
The majority of credit unions and online lenders offer debt consolidation loans. However, each financial institution has unique loan requirements, and the rates may vary. Therefore, to find the best consolidation loan with bad credit, you should:
The best way to find a debt consolidation loan that works for you is to shop around. Contact multiple credit unions and online lenders to see who offers the sort of products you are looking for.
Keep in mind that the person you are speaking with will try to convince you to complete an application. If you do, they will run your credit to determine whether you qualify for the loan. While that is not necessarily a bad thing, too many inquiries can damage your credit score and make it even harder to qualify for a debt consolidation loan.
Use an Online Loan-Finding Tool
If you don’t want to contact lenders directly or visit your local credit union, you can use a loan-finding tool on one of the many financial platforms online. The way these platforms work is relatively simple.
You provide some basic information about the type of loan you are looking for, your estimated credit score, and the amount you need to borrow. The platform will then provide a few potential lenders that meet your criteria. These recommendations include estimated rates and monthly payment amounts, which are reasonably accurate.
The downside to using these sites is that they require you to consent to the sharing of your data. As soon as you submit your information request, you will be bombarded with phone calls, texts, and emails from online lenders.
Take Advantage of the Credit Report Grace Period
Once a lender runs your credit, you enter a grace period, which allows you to shop around. While this grace period varies in length, it usually lasts 14 calendar days. From the moment you apply for a debt consolidation loan and have your credit checked, you have two weeks to compare as many options as you want. Whether your credit is run one time or 100 times, you will only be penalized for a single inquiry.
If you want to avoid a flood of phone calls and emails, do your own research and reach out to a few lenders directly. When you are ready to apply for a debt consolidation loan, have a list of options ready to go so you can efficiently shop around during your grace period.
How to Use a Debt Consolidation Loan to Get Out of Debt
Using a debt consolidation loan is relatively simple. It involves the following steps:
- Identify your highest-interest debts
- Determine how much you need to borrow
- Obtain a debt consolidation loan
- Pay down on the loan
- Use your extra cash to build a savings account
- Once you have an emergency fund, pay extra on your loan (or another debt)
Each time you pay down a debt, roll that extra money toward the next bill you want to eliminate. Repeat this process until you are debt free.
Not sure which bills to pay down first? If you need help deciding which bills to focus on, consider using the debt avalanche method or debt snowball method. Here is a breakdown of each approach:
Debt Snowball Method
The debt snowball method involves paying off your smallest debt first and then moving on to the next one. For instance, let’s say that you took out a debt consolidation loan and paid off three credit cards. You now have the following debts:
- A credit card with a $1,000 balance ($100 monthly payment)
- A debt consolidation loan with a $10,000 balance ($200 monthly payment)
- An auto loan with a $15,000 balance ($400 monthly payment)
In this scenario, say that you freed up $200 per month by consolidating your debt. With the debt snowball method, you would apply that extra $200 to the credit card because it has the smallest balance. Instead of paying $100 per month, you would now pay $300 per month.
When you pay off the credit card, you would then combine that $300 with the $200 you normally pay toward your consolidation loan. Cumulatively, you would pay $500 per month toward the consolidation loan balance. When that is paid off, you turn your attention to the auto loan.
Debt Avalanche Method
The debt avalanche method uses the same basic premise as the debt snowball method. When you pay off one debt, you apply the money you were spending on that bill toward the next item on your list. However, the difference is which bills you pay first.
Whereas the snowball method involves paying the smallest debt first, the avalanche method prioritizes the debt with the highest interest rate. In our example above, let’s say the credit card had an interest rate of 10%, and the debt consolidation loan had an interest rate of 11%. In this scenario, you would pay off the loan first, then the credit card.
Alternatives to Debt Consolidation
Debt consolidation loans for bad credit are not the only path forward. If you need to shed some debt and lighten your financial burden, consider the following:
Debt Management Plans
A debt management plan is an agreement between you and a creditor. A credit counseling agency usually sets up the agreement. The agency will help you get fees waived and break your debt into more manageable monthly payments.
Credit counseling agencies also provide education and guidance designed to help you get out of debt for good. They can provide tips for building your credit and offer guidance as you work to build an emergency fund.
By filing for bankruptcy, you can get relief from some (or in some cases all) of your debt. While your credit score will plummet, you will drastically reduce your monthly payments and get a fresh start.
Explore Your Options with CrossCountry Mortgage
As you can see, there are various options for qualifying for debt consolidation loans for bad credit. However, personal loans often have shorter repayment terms and higher interest rates than secured loans like refinancing, a home equity line of credit (HELOC) or a home equity loan.
With that in mind, you may want to consider tapping into the equity in your home so that you can access a lower interest rate and wipe out several of your existing debts all at once. To learn more, connect with CrossCountry Mortgage to chat about your options.
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