You may consolidate your debt in two ways: by taking out a consolidation loan or by using a credit counselor to create a debt management plan. The processes for these two consolidation types are very different. With a consolidation loan you must have good-enough credit to qualify for the loan, while on a debt management plan you must be in a dire-enough position that credit counselors see you as a bankruptcy risk. Both plans, if used correctly, may help you to get out of debt, but it's important to understand their risks as well.
Credit Report
The first step in the process of consolidating your debt is gaining an understanding of where you stand creditwise. You may order your credit report for free on the Federal Trade Commission-approved Annual Credit Report website. Consolidation loans usually require collateral, such as your home, as well as fairly good credit. By reviewing your credit report, you know of any errors, which you can report, in writing, to both the creditor and credit bureau. By improving your credit score, you may be able to qualify for lower interest rates on your consolidation loan. Understanding your credit is also important in developing better financial management and understanding your circumstances if you want to take on a debt management plan.
Consolidation Loan
A consolidation loan wipes out your current balances, so you make one monthly payment to the loan instead of making payments to your multiple debts. Applying for a consolidation loan requires the lender to make an inquiry to your credit report, which creates a negative effect on your score because it means that you are potentially getting more credit. After you've been approved for a consolidation loan, your balances are zeroed out --- this is where people run into trouble. You must be committed to keeping your debts paid off and paying down your loan to be successful with a consolidation loan. If you begin using your newly freed credit, you may spiral further into debt.
Debt Management Plans
The first step to obtaining a debt management plan, or DMP, is to meet with a credit counselor. Only a credit counselor has the power to decide whether or not you should be on a DMP. You must have already defaulted on your payments and/or be having difficulty making payments to qualify for a DMP, which is seen as a last resort before bankruptcy. After you've been approved, your credit counselor consults with your creditors to attempt to negotiate lower interest rates and/or balances. Then the counselor prepares a time frame over which you pay off your debt. Each month you make payments to the credit counseling company, which then pays your creditors. If the counseling company is late on payments to your creditors, your credit score could be severely damaged, so it's important to check with the Association of Independent Consumer Credit Counseling Agencies or the National Foundation of Credit Counseling to make sure your counseling company is legitimate.
Considerations
Prior to applying for a consolidation loan or a debt management plan, it's a good idea to see if you can work out your debt on your own. Both consolidation types are seen as dark marks on your credit report. With a consolidation loan, you may have difficulty obtaining new credit over the life of the loan, as it demonstrates to lenders that you've had trouble with your finances in the past. On a DMP, you may be prohibited from obtaining new credit while on the plan; afterward, you may continue to have difficulty getting lenders to have faith in your ability to pay your debts. By asking for lower interest rates on your credit cards, you may find that you have the ability to pay off your debts independently.
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