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How to Consolidate Your Debt - the RIGHT Way

Posted on April 28, 2015

Bills coming in the mail every day can quickly get discouraging. When they are overdue, it's all the more demoralizing. Consolidating your debts is one way to reduce how much you pay each month. Here is a look at ways to handle too many bills and the right approach to implementing solutions that will help you forge ahead.

Why Consolidate?
Paying less each month is the biggest reason to think about consolidating your credit card debt and other loans and bills. By consolidating, you can start paying down the debt in a consistent way. If you have multiple credit card payments to make each month, it's easy to fall behind. Your credit score takes a hit each time you fail to pay on time. By consolidating your debts, you make it more likely that you'll be able to pay on time.

A low credit rating can have pervasive effects, affecting many areas of your life and coming back to haunt you each time you face a major financial decision. For example, you might have a hard time getting a mortgage, many employers use your score in hiring decisions, you'll almost certainly pay more for auto insurance, and more. Lower payments each month will ease the stress that comes with constantly getting bills you don't know how you'll be able to pay. The stress can hurt your health and confidence, making it hard to perform well at work and on the home front.

Ways to Consolidate Your Debts
There are five main ways to consolidate your debt. Each has its pros and cons, a right way and wrong way. Keep reading for the advantages of each method, and the right way to go about pulling it off.

Get a Loan from a Family Member or Friend
The upside of accepting help from someone you know is that it is usually a quick process and doesn't require a load of paperwork. The downside is that it can cause undue strain in relationships if payments aren't made on time or if one party is always loaning money to the other without being repaid consistently. Also, it can just be tough to ask for help.

The Right Way
Be sure to write everything down, like the amount of the loan you'll need, the duration it would cover, how often payments would be made and how much you would pay in each installment. Draw up terms similar to those you might if you were taking out a loan from a bank. It is essential that both parties understand all the details. Having a formal contract will make both parties more comfortable and make all the terms clear from the outset.

Contact Your Creditors Individually
This actually isn't debt consolidation, strictly speaking, but it is a way to potentially reduce how much you owe each month. Sometimes creditors will voluntarily lower how much you must pay each month, reduce interest rates or change your monthly due date. The upside is that you pay less each month. The downside is that paying off your loans will take longer, and could cost you a lot more in interest in the long run.

The Right Way
Go to a nonprofit credit counselor who has experience setting up payment plans and dealing with creditors. She can advise you how to do it correctly, or perhaps make the contact for you. Ideally, you'll be able to find a payment plan that won't cost you more in interest in the long term.

Transfer Your Balances to a Zero- or Low-Interest Rate Credit Card
The upside to transferring your existing credit card debts to one card is that you pay one bill each month, and it is almost always less than the sum of your previous monthly credit card payments. The downside is the zero- or low-interest rate is typically limited to a specific period of time, usually 12 months, according to the Consumer Financial Protection Bureau. At that point, the rate goes up and your monthly payment goes up with it. Another thing to consider: if you are late with payments, the rate will go up immediately.

The Right Way
Read all the fine print. Understand how long the initial percentage rate will last. Find out if there are other fees, like a balance transfer fee or additional interest on new purchases. And shop around! Other creditors might have more advantageous offers, so it's always worth checking around.

Get a Home Equity Loan
This is tempting because your biggest asset is just sitting there, waiting to be put to use. The upside is that your interest rate will be low because, in effect, you are using your home as collateral. The downside is you could potentially lose your home if you can't pay the loan back or can't pay it on time.

The Right Way
Check with an accountant to find out how much you can afford before chancing a home equity loan. This is a fairly drastic way to consolidate debt, and it's likely that there are simpler changes with fewer risky potential consequences.

Take Out a Consolidation Loan
Consolidation loans are available from credit unions, banks and installment lenders. The upside is you have just one payment to deal with each month and it is often less than the total of the multiple bills you were juggling. The downside is if you get socked with new bills, you may not be able to pay them in addition to the debt consolidation loan payment each month. The result could put you further in debt than you were to begin with.

The Right Way
Make sure you understand what rate you will be charged for the length of the consolidation loan. Sometimes the initial rate is simply a "teaser" to get you to sign up, and the rate will increase later in the loan period. Also, find out about any hidden fees or costs before taking out any loan.

Consolidating your debt can give you breathing room, both financially and emotionally. But like all financial actions, it is complicated. Do your research and ask experts, such as an accountant or debt counselor, for advice. After getting help, be sure to stay on top of your bills so you aren't back where you started.

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