If you have bad credit, you first need to figure out where you're starting from by taking a good, hard look at your current credit standing. When you understand your starting point, you'll be able to figure out the best route out of debt. Debt consolidation through a consolidation loan or, in more drastic circumstances, a debt management plan may or may not be the appropriate route to your financial freedom.
Credit Score
Each year, everyone in the U.S. is entitled to a free copy of their credit report from each of the three credit bureaus (Experian, Equifax and TransUnion). The Annual Credit Report website is the only website under the Fair Credit Reporting Act and the only one recommended by the Federal Trade Commission (see Resources). Once you have your credit report, comb through it to see if there are any errors. If you find any, report them immediately to both your creditor and the credit bureau by writing a letter and providing any documentation (see Resources).
Take Inventory
Before making a commitment to any type of consolidation, you must first figure out how much you can realistically pay toward your debt each month. To be successful in using a consolidation plan and to avoid spiraling further into debt, you must be completely committed to making your monthly payments on time each month and keeping the debt paid off forever. According to Bankrate, 70 percent of people who take on some type of debt consolidation end up in the same amount of debt or more within two years.
Lower Interest Rates
See what your credit card company has to offer you by way of lower interest rates. Consolidation loans and debt management plans are seen as dark marks on your credit report because they indicate to lenders that you have been financially irresponsible in the past. Also, the rock bottom interest rates advertised on consolidation loans are generally for those with stellar credit, so if you can lower the interest rates on your cards you may end up with a better deal than a consolidation loan. Use any credit card offers you've recently received to come up with a target interest rate, then call your creditor to for a reduction in your current rate.
Consolidation Loan
If you can get a low enough interest rate on a consolidation loan, it may make your overall debt less costly. Consolidation loans also have the added benefit of allowing you to make one monthly payment rather than individual payments to your multiple accounts. However, the loan effectively wipes out your current balances, which frees up the credit on your cards -- you must avoid falling into the trap of spending on this credit to pay off your debt. Applying for a consolidation loan requires a lender to make an inquiry into your credit report, which causes a negative impact on your score. If you manage to pay off your debt with the consolidation loan (and keep it off), the positive impact far outweighs the negative one. You may, however, have difficulty attaining new credit while using a consolidation loan.
Debt Management Plan
Those who are already delinquent on their payments and who are having a hard time meeting minimum payments should consult with a credit counselor. Only a credit counselor may recommend a debt management plan or DMP. These plans are seen as the last stop before bankruptcy. Once you decide to enroll in a DMP, your credit counselor will work with your creditors to try to negotiate lower interest rates and pay off balances. Once your counselor has created a plan for you, he will lay out a specific timeline, at the end of which your debt will be paid off. Bankrate warns that you should check with the Association of Independent Consumer Credit Counseling Agencies or the National Foundation of Credit Counseling to confirm that your credit counseling company is reputable.
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