Debt Consolidation: The Pros and Cons of Your Major Options

Do you want to have fewer bills to pay each month and save money at the same time? Who doesn’t?! But simply consolidating a bunch of debts at a lower interest rate won’t necessarily get you there. Consider the pros and cons of all your options – and then manage your debts and cut back on spending over time.

Once you choose a debt consolidation method, make sure you keep the total cost as low as possible. Here are three tips to up the odds that your debt consolidation plan will work:

1.Don’t take the maximum amount of time possible to pay off your new loan. Instead, come up with a plan to get out of debt in three to five years.
2.Read the fine print so there are no surprises, such as a balance transfers or application fees.
3.Ignore all offers that sound too good to be true.
Tip for folks in really bad financial shape:
If you are in serious money trouble and are feeling overwhelmed by all the bills, before you do anything else, take advantage of Credit.com’s debt consultation service. It’s free, private, and a real live human being will go through your options with you, one of which might be to work with a non-profit credit-counseling agency that can negotiate with your creditors on your behalf.

Homeowners Have Great Options
If you’ve built up some equity and the interest rates remain favorable, it may make sense to refinance your home and use the additional cash you can borrow, over and above what you owe on your current mortgage, to pay off more expensive debts. Or you might be better off taking out a home equity line of credit (HELOC) or a fixed rate home equity loan. You can start your research with Credit.com’s Mortgage Guide .

Pros:

You can save a fortune by switching debts from the double-digits of typical credit card bills to the much lower rates on home equity loans and refinances.
There’s the possibility of being able to deduct the interest on home loans, whereas that’s not possible with credit card debts.
If you shop carefully, you’ll be able to get a good deal on closing costs, saving you more money.
Cons:

You’re putting your home on the line, which is extremely risky unless you are certain you can trust yourself to stop over-spending and to faithfully pay off the home loan(s).
If you go for a variable rate loan, remember that what goes down may well go up, increasing your cost of borrowing.
Don’t unwittingly extend the length of time you’ll be in debt or it might cost you more over the long run than if you’d simply paid off those higher rate bills.
Tips:

Don’t pocket the money your refinancing frees up every month. Instead, use it to create an emergency fund (if you don’t already have one). Once that’s set up, use the money as a pre-payment against your home loan or to boost your retirement savings.
Ditto with any tax refunds that come your way.
Cardholders Have Great Options
One of the easiest ways to consolidate your credit card debts is to call your current card issuers and ask them to give you a better deal. If the customer service representative seems unwilling, don’t be shy! Ask to speak with a supervisor.

Lenders know the competition is tough, and it’s cheaper for them to keep you than it is to get a new customer to replace you – especially if you’re a “low maintenance” borrower who pays bills on time. While you have them on the phone, ask about these three issues:

1.Getting a special rate on any new balances that you transfer to their card.
2.Getting the interest rate lowered on new purchases.
3.Getting any annual fee waived.
Pros:

A phone call or two to a toll-free number is all it takes. It doesn’t get much easier than that!
You have nothing to lose and you may save yourself a lot of money – now and over the long haul.
Cons:

Especially if you have a spotty payment record, it may not work!
Instead, try getting a new, low rate credit card at Credit.com. This is admittedly more of a hassle than making one toll-free call, but if you’re honest about your credit situation as you look over the offers, you may find a lower rate card without too much trouble.
Tips:

Ask that any balance transfer fees be waived.
Don’t apply for too many new cards at one time. It can hurt your credit score. So choose carefully!
Watch out for teaser rates. While you can save the most by strategically transferring your debt to another low introductory rate card whenever the last "teaser" rate is about to expire, the constant balance swapping can burn you out, and if you flub it, you could pay for it. Instead, try to find a card with a steady, low interest rate.
Be sure to plow your savings back into your debts.
Can You Borrow from Your Nest Egg?
The answer is “Yes!” if you have:

1.A 401(k), 403(b) or certain other kinds of pension plans
2.An IRA
3.Investments, such as stocks and bonds (loans against them are called "margin" loans)
The key word to remember here is borrow. It’s one thing to take a loanagainstyour future nest egg. That alone raises many issues worthy of your consideration! But if you were to withdraw retirement funds early instead, from your 401 (k), for example, you’d have to pay taxes and a 10% penalty.

The interest rates on these loans tend to be low – or even interest-free. For example, you can use money from your IRA interest-free for 60 days. However, you must “roll it over” to another IRA account within 60 days. Don't use your IRA to pay debts unless you are 100% confident the money will be replaced within two months, say, with a tax refund you are guaranteed to receive. Otherwise, you'll be hit with a penalty and taxes on the funds. (Of course, while you’re using your IRA money, it won’t be earning you any interest either.)

Pros:

If you have no credit history or a poor one, these borrowing options might make sense, since they require no credit check and are easy to get.
The interest rates are generally low, and since you’re the lender, the interest gets paid to you (in the case of retirement funds). As far as margin loans and IRAs are concerned, you don't have to make interest payments on them at all.
Cons:

Should you lose your job, you might have to pay back your retirement fund loan immediately … or pay taxes and penalties and have it treated as an early withdrawal.
You could end up robbing your retirement fund if you rely too much on these loans.
If you fall behind on your re-payments, even though they are to yourself, the IRS will treat a retirement fund loan as an early withdrawal -- 10% plus taxes.
Since there’s always a risk of a “margin call” if the market crashes, most advisors urge caution here – that is, keep margin borrowing at 20-25% of your investment account. (With a margin call, you may be called on to immediately pay back the loan, which may mean selling stock at an unfavorable time.)
Don't use your IRA to pay debts unless you are absolutely certain that you can come up with the funds within 60 days. Otherwise, you'll be hit with a penalty and taxes on the funds. Speak with a tax professional before undertaking an IRA rollover to be certain your plan is sound. For example, the funds have to be returned to an IRA account (same one or different).
Personal Loans


1. From friends and family:
These loans can be your best bet or worst nightmare. Ideally, you offer your parents or another private lender an interest rate that’s better than what they’re getting at the savings bank.

Pros:

Everyone can win! They get a higher rate, you get a lower rate, and you’ll be able to quickly get out of debt.
Depending on how the deal is structured, you both may even be able to get some tax perks. Talk to a tax pro or a lawyer.