How to consolidate debt without a loan
Key takeaways
- Debt consolidation loans may not be the best option for every financial situation.
- Balance transfer credit cards and home equity products are debt consolidation alternatives that may be less expensive.
- Other alternatives, like debt settlement, debt management plans and bankruptcy, can be costly options both in terms of money and financial health.
Debt consolidation loans are personal loans that allow you to combine multiple debts into a single account, making for a more straightforward repayment. Because these loans require good credit or a creditworthy co-applicant, they are not the best choice — or even an option — for everyone.
You aren’t limited to just personal loans, however. There are debt consolidation options available that don’t involve borrowing an installment loan. And some of them — including DIY strategies and debt management plans — don’t require borrowing at all.
Why a debt consolidation loan might not be the best strategy
It requires you to change your financial habits
A debt consolidation loan can simplify debt repayment and — assuming your credit has improved since you last borrowed — even save money in the long run. For it to be effective, however, you must identify and address the issues that led to your debt in the first place. Otherwise, you will simply be playing a game of musical chairs: moving debt from one place to another — not solving the issue and potentially sinking you deeper into financial trouble.
It may not be helpful if your credit needs work
Consolidation options like bad credit loans might not be the best approach. That’s because lenders, in an effort to mitigate their risk, charge applicants with imperfect credit higher interest rates. This, combined with potential origination fees, can make personal loans costly, defeating the purpose of consolidation.
Debt consolidation loan alternatives
Typically, debt consolidation loans are unsecured personal loans, meaning that lenders rely on your credit, among other financial factors, to determine your eligibility. If you don’t have good credit, a creditworthy co-applicant or collateral for a secured loan, consider other ways to approach debt consolidation.
1. DIY methods
Committed borrowers who are willing to make hard choices and get organized. While a DIY approach is a tried-and-true way to pay off debt without re-borrowing, it requires a lot of personal effort.
It may seem counterintuitive to borrow a new personal loan to pay off past borrowed credit. With a do-it-yourself approach, however, you can avoid a new account.
Optimize your budget
Getting rid of debt starts with improving your cash-flow so that, each month, you can make extra payments toward your outstanding balances. You might consider:
- Canceling subscriptions you no longer use or sharing accounts
- Cutting out or cutting back on unnecessary spending
- Shopping for cheaper car insurance, internet, home insurance or cell phone plans
The other lever you can pull to improve your cashflow involves your income. Asking for a raise at work, picking up a side hustle and renting out or selling unwanted items are all ways to earn more cash to put toward your debt.
Pick a repayment method
Once your basic budget is fine-tuned, it’s time to list out all of your debt accounts, including their interest rate and outstanding balance. This may help you feel more prepared to choose a debt payoff plan. Two common options are the debt snowball and debt avalanche.
Once your basic budget is fine-tuned, it’s time to list out all of your debt accounts, including their interest rate and outstanding balance. This may help you feel more prepared to choose a debt payoff plan. Two common options are the debt snowball and debt avalanche.
- Debt snowball: Throw your extra cash toward your lowest-balance account until it’s paid off, then tackle the account with the next-lowest balance. This will create a “snowball” effect and can keep you motivated to end your debt for good.
- Debt avalanche: Apply your extra payments toward your highest-interest account until it’s closed, then proceed to the debt with the next-highest APR. This method may not provide the motivating quick wins of a debt snowball, but it will save you the most money on interest while you’re in repayment.
Although this debt consolidation method requires accountability, taking these steps could free up cash and help you work toward a zero debt balance.
2. Balance transfer credit card
Creditworthy borrowers who are carrying multiple credit card balances but have enough dependable cash-flow for a months-long repayment. Balance transfers typically have strict eligibility criteria and are only wise if you can pay off your balance before the card’s promotional period expires
A balance transfer card allows you to combine debts from other credit cards — usually credit cards from other companies only — at a temporary interest rate. Borrowers with strong credit profiles may even qualify for a 0% promotional rate.
This introductory rate typically spans 12 to 18 months, though a few cards may offer up to 21 months. Only applicants with good to excellent credit are likely to be approved.
Once the introductory period ends, you’ll be responsible for paying the card’s standard interest rate on the remaining balance. Additionally, most cards charge a balance transfer fee on the total amount you transfer, typically from 2 to 5 percent.
3. Home equity loan or HELOC
Budget-minded homeowners with sufficient equity in their home. Mortgage lenders typically require you to own at least 20 percent of your home outright.
Home equity loans and home equity lines of credit (HELOCs) allow you to borrow against the equity that has accrued in your home. A home equity loan delivers a lump sum and features set monthly payments at a fixed interest rate. Compared with debt consolidation loans, both options often have longer repayment periods, larger loan amounts and lower interest rates.
A HELOC works like a credit card and has a variable interest rate. The amount you pay in interest is directly related to how much money you draw from your credit line. Since your debt is likely to be a set amount, you might prefer the unchanging monthly payment of a home equity loan.
Both home equity products can be used to consolidate high-interest debt, but you’ll risk losing your home if you can’t pay them back. That’s because your home serves as the collateral for the loan, much like your primary mortgage. This risk typically translates to lower rates, but you should be aware of potential consequences before you make a plan to borrow.
4. Cash-out refinance
Borrowers with less-than-perfect credit who won’t be raising their mortgage interest rate. Borrowers with fair or poor credit could leverage their home equity for more favorable terms than other alternatives to debt consolidation loans.
A cash-out refinance replaces your existing mortgage with a brand-new one that’s larger than your current outstanding balance. You can withdraw the difference between the two balances and use it to improve your home or consolidate debt. As with using a home equity loan or HELOC, you must have sufficient equity to be eligible — and you’ll risk losing your home if you can’t repay your new loan.
Other eligibility criteria include your credit score and debt-to-income ratio. If you don’t have strong finances, you could face a higher interest rate, limiting the benefit of refinancing.
Think twice before refinancing your home loan if you currently enjoy a COVID-19 pandemic-era interest rate. If your mortgage APR is between 3 and 5 percent, for example, refinancing to today’s elevated rates could be a costly decision. It would mean paying far more in interest over your repayment term. Instead, if you’re intent on leveraging your home equity, you might consider a home equity loan (see above).
5. Debt settlement
Consumers with at least five figures of debt who are hoping to avoid bankruptcy. Debt settlement isn’t guaranteed to work, and even if it does, it incurs fees and could impact your credit negatively for several years.
Debt settlement is when you negotiate with your lender to pay a lower amount than what’s owed to satisfy the debt. You can negotiate with the debtor yourself or pay a fee to a debt relief company or lawyer to negotiate on your behalf. Be warned: Debt relief companies typically charge 15 to 25 percent of the debt enrolled, and not all creditors will engage with these firms.
This strategy is likely to damage your credit score because the debt settlement representative may advise you to stop making payments. Most lenders will not consider negotiating your debt unless you’re significantly behind in repayment — and they don’t believe you’re capable of fully repaying your balance.
If you successfully negotiate a settlement — which isn’t a guarantee — the settled debt will be marked as such on your credit report. It will stay there for seven years and may make it difficult for you to qualify for new credit. That said, if you’re swamped in debt, and the other alternative is bankruptcy, then this tactic is at least worth exploring.
6. Debt management plan
Those with overwhelming debt who are seeking an alternative to settlement. These plans deliver relief after a three-to-five-year repayment plan, so it may take longer to resolve your debt.
Nonprofit credit counseling agencies offer debt management plans. They involve working closely with a counselor who evaluates your debt and the best approach to tackle it. Typically, the counselor contacts your creditors in an attempt to make your debt more manageable. They may be able to settle some accounts or lower your interest rate or monthly payment.
You’ll make monthly payments to an account created by the credit counseling agency, and they will pay your creditors. Additionally, you will be provided with tools to help you stay out of debt.
Like with settlement, a debt management plan can ding your credit in the short term. Over the long haul, however, you’ll be in a stronger position to rebuild your credit.
7. Bankruptcy
People who have exhausted all other options. Bankruptcy isn’t the fresh start it’s often cracked up to be. While it can provide relief, it stays on your credit report for 7 to 10 years, depending on the type of bankruptcy.
Filing for bankruptcy involves going to a federal court to discharge your debt or reorganizing the accounts to give you time to pay them off. That said, some debt types, like federal student loans and tax debt, are historically difficult to discharge.
Before you choose this debt consolidation alternative — a true last resort — remember that your credit score will suffer a major blow that can take years to recover.
If you proceed, it’s wise to commit to paying your bills on time and establishing a budget. These and other steps can help you recover from bankruptcy without falling back into bad habits.
What’s your next step?
Compare your debt consolidation options by weighing factors like eligibility requirements, interest rates, fees and repayment terms. Additionally, think about the risks and trade-offs of each alternative. Using a debt consolidation calculator can help you run the numbers.
