Managing Debt

How Does Debt Consolidation Work?

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If you're trying to pay off debt, it can feel like you are using a bucket to bail out a boat taking in water. You are not alone. The average U.S. household has $8,701 in credit card debt. But you don't have to be lost in a sea of debt. There are a variety of strategies to address your debt through consolidation.

Debt consolidation allows you to reduce the stress of multiple payments and due dates by getting a lower, fixed-interest rate loan. The loan gives you funds to pay off the debts, so that you only have to make one monthly payment for the term of the loan. When considering how to consolidate debt, the idea is to pay less interest and/or get out of high-interest debt sooner than if you'd stayed the course with multiple lenders—and gain some peace of mind along the way. But with credit cards, car payments, student loans, mortgages, and medical bills, where should you start consolidating?“

The most expensive debt (highest interest rate) should generally be attacked first," says Louis Cannataro, founder of Cannataro Park Avenue Financial. “Then look at loans with interest rates that can increase. This is like glass on the beach … an accident waiting to happen especially in an environment where rates are most likely going to rise not fall. Keep in mind, some home loans can be tax deductible, slightly reducing net cost of the interest charged."

3 types of debt consolidation loans

Home equity loans and home equity lines of credit: Homeowners can take out a home equity loan (HEL), which can be a second mortgage or a cash-out refinance of a first mortgage using the available equity in their home to pay off debt. Because this type of loan is secured (your house is the collateral), you can generally get lower interest rates and longer repayment terms than with other products. With Discover® Home Loans you can get a low, fixed interest rate loan with zero application fees, zero origination fees, and zero cash required at closing. Other lenders may also offer a home equity line of credit (HELOC) which offers the flexibility of drawing the amount of cash you need when you need it. This functions as revolving debt, much like a credit card, but usually comes with a variable interest rate that can go up or down over the course of the loan.

Unsecured personal loans: An unsecured personal loan from a bank or credit card does not have collateral (hence it is “unsecured"), so its interest rates tend to be higher and repayment terms tend to be shorter than a HEL/HELOC.

Balance transfer credit cards: Balance transfer credit cards move debt to a single credit card often offering an enticing introductory APR. Once the introductory period is over, these cards usually switch to high APRs, which is not helpful when trying to get out of high interest debt. Beware of associated fees, too.

How a good debt consolidation strategy works

Here's how debt consolidation can be useful to deal with your debt.

1. Reduces your monthly payments

With a debt consolidation loan, you can select terms that work for you. This could mean a longer repayment period, resulting in a lower monthly payment, and/or an interest rate that is lower than what you are currently paying. By setting these terms, you know how long you will be in debt, which lends a sense of control.

2. Reduces your interest charges/rates

Seek a debt consolidation product with a lower interest rate than you are paying on your current debts. This could result in less interest being paid over the life of the debt if you do not increase your repayment term, which could save you a significant amount of money.

3. May help to improve your credit score

Your credit utilization rate, or your ratio of debt to available credit, can impact your credit score. A debt consolidation loan may help you to pay off the debt more quickly, which could improve your credit score.

4. Simplifies your bill paying

Consolidating your debt simplifies your monthly bill paying cycle. Instead of having a multitude of different payments due on different days, you have just one set payment, thus reducing stress and the potential to miss a payment, which can impact your credit score.

How to apply for a debt consolidation loan

Ready to apply for a debt consolidation loan? Here are your next steps.

How to apply for a Home equity loan/HELOC

Most home equity loan applications begin online. For Discover Home Loans, the online application can take less than five minutes. The overall loan process generally goes like this:

  1. Fill out the Discover Home Loan's preliminary application with information about yourself and your home.
  2. Your lender will pull your credit score and check your debt-to-income ratio.
  3. You'll then need to provide documents to substantiate your property and financial information, which include things such as your income statements, mortgage statement, homeowners insurance declaration, and photo I.D.
  4. Next the lender's processing, underwriting, appraisal teams begin their evaluations.
  5. Once the lender approves your loan, you will set up a closing to sign your documents and receive your loan funds or credit line. Some lenders, like Discover Home Loans, will pay off your creditors directly so that you don’t have to worry about sending individual payments yourself.

How to apply for an unsecured personal debt consolidation loan

For an unsecured personal debt consolidation loan, it takes about one to seven days to disperse funds.

  1. Fill out Discover Personal Loan's pre-qualification application online or by phone.
  2. With this information, the lender can determine an interest rate and term to offer you.
  3. Should you decide to accept it, the lender would verify your identity and credit information.
  4. The lender pays the creditors directly so the loan does not appear as new debt but transferred debt.

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  • Weekdays 8am–Midnight ET
  • Weekends 10am–6pm ET