If you’re drowning in debt, you might be feeling a sense of helplessness. You’re not alone. U.S. households carry an average of $110,095 in debt, according to data from the Federal Reserve and U.S. Census Bureau.
Your borrowing options are probably limited because of how much debt you have, and your credit is likely suffering.
At this point, the only thing that’s going to help you get back on your feet is to start tackling your debt. To help you determine the right strategy, we’re comparing two popular options: a debt consolidation loan and a debt management plan.
Find out which approach is right for you based on how much debt you have, the type of debt you have, and your credit situation.
Debt consolidation loan
Debt consolidation can help you roll several debts into one, preferably with a lower interest rate.
There are several loans you can use to consolidate debt, including a personal loan, balance transfer credit card, or home equity loan. Here are a few pros and cons of this approach.
Pros of a debt consolidation loan
- You can consolidate just about any type of debt.
- You might qualify for a better interest rate, which can help you save money.
- You’ll have one payment to remember instead of several.
- You can borrow money while you’re paying down your debt.
Cons of a debt consolidation loan
- If your credit is bad or fair, you might not qualify. If you do, your interest rate might be high.
- If you continue to borrow while you’re paying off your loan, you could dig yourself into a deeper hole.
- You might be on the hook for loan origination fees or balance transfer fees.
Debt management plan
Like a debt consolidation loan, a debt management plan can help you consolidate your debt into one monthly payment, preferably with a lower interest rate.
But instead of paying your new creditor, you make your payments to a debt counseling agency, which sends the money to your creditors.
“A debt management plan can typically include most forms of unsecured debt, such as credit cards and small balance loans,” said Bruce McClary, vice president of communications for the National Foundation for Credit Counseling. “But it excludes collateralized loans like mortgages and auto financing.”
Debt management plans typically take three to five years to complete, and you’re usually not allowed to borrow more money until you’re done. In fact, your creditors might suspend or even close your accounts so you can’t use the credit cards or lines of credit you currently have.
Pros of a debt management plan
- It offers forced discipline to help you avoid borrowing more money while you’re paying off your existing debt.
- There’s no special credit requirement because you’re not applying for a loan.
- You have just one payment instead of several.
- You might get a reduction of your interest rates.
Cons of a debt management plan
- You’re required to include all your debts in your plan, not just the ones that are giving you trouble.
- It could hurt your chances of getting approved for credit or an apartment because it signifies that you’ve had financial difficulties.
- Creditors might report that you’re not paying as originally agreed, which could damage your credit score.
- You’re limited on which debts you can include.
Debt consolidation vs. debt management: Which Is right for you?
There’s no best approach to paying down debt. What’s important is that you consider each strategy carefully to determine which is better for your situation.
“A debt consolidation loan may be a better option for someone with a high credit score and a modest amount of debt,” said McClary. “Debt management plans are most appropriate for those who are in danger of falling behind on their creditor payments due to debt balances that have grown beyond the point where they are under control.”
Whichever option you choose, it’s critical to address the real issue at hand: why you got into debt in the first place and whether it will happen again.
Take an honest look at how you got to this point and take steps to ensure you don’t repeat your mistakes. For example, if your credit card spending spiraled out of control, consider getting rid of your credit cards or requesting a lower credit limit to avoid the temptation to overspend.
If you fell into debt slowly because you didn’t keep track of where your money was going, consider creating a monthly budget and sticking to it to develop more spending discipline.
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