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How to Consolidate Debt with Bad Credit

Written by:
Financial Literacy Specialist

Even if you can’t qualify for a loan, you may still be able to consolidate your debt.

Credit card consolidation allows you to lower your monthly payments and reduce interest charges so you can eliminate debt efficiently. The only problem is that most debt consolidation solutions require you to have a good credit score to qualify. If you have bad credit, you either can’t qualify for a loan or can’t get the interest rate you need for consolidation to be beneficial.

So, how do you solve debt problems if you don’t have the credit score necessary to qualify for consolidation?

The answer: Nonprofit consumer credit counseling

Consolidating debt through a credit counseling service

When you consolidate credit cards through a credit counseling service, your credit score is not a factor. Instead, you only need to be able to meet the adjusted payment schedule on your debt customized Debt Management Plan.

Here’s how the process works:

  1. You contact a credit counseling agency to request a free evaluation.
  2. A certified credit counselor reviews your budget, debts and credit to see where you stand.
  3. If you have bad credit, this eliminates any do-it-yourself relief options, because you won’t be able to qualify.
  4. However, as long as the credit counselor can verify your income, you can usually find a Debt Management Plan payment that works for your budget.
  5. Once you craft a repayment plan that you can afford, the counseling team starts to negotiate with your creditors.
  6. The counseling team also negotiates to reduce or eliminate interest charges and stop future penalties on each debt.
  7. Once all your creditors agree to the program, your payments start; you pay the credit counseling agency one payment each month and they distribute the funds on your behalf.
  8. This helps build positive credit history and reduces your credit utilization ratio, which are two driving credit score factors. As a result, your bad credit score often improves when you complete a Debt Management Plan successfully.

At the same time, you can access free resources that the credit counseling agency offers. These can help you learn how to live without relying on credit so you can avoid debt in the future.

Here’s one example of how a debt management program helped a client take control when retail therapy went off the rails:

Why doesn’t DIY work for consolidating credit with a bad score?

There are two ways to consolidate credit card debt on your own. But both require that you apply for a new line of credit in order to consolidate. With a balance transfer credit card, you must open a new credit card account. If you take out a personal consolidation loan, you must qualify for the loan.

A bad credit score will lead to one of two outcomes:

  1. You get rejected for the loan or credit card outright.
  2. You qualify for rates and terms that don’t provide the benefit you need.

The second is more dangerous than the first. If you get rejected, you simply move on to credit counseling. However, in the latter case you must make a judgment call about whether the rate is low enough to benefit you. This can be tricky.

Comparing monthly and total cost

When choosing any debt relief solution, there are two costs that are critical to consider:

  1. Can you afford the monthly payments?
  2. What will be the total cost you incur to get out of debt?

Interest rates are directly tied to total cost. Higher interest charges mean your debt costs more to pay off. So, a higher rate means higher total costs. When the interest rates are too high, it means that you can’t pay back what you owe efficiently or effectively.

So, let’s say you can only qualify for 12% APR on a personal credit consolidation loan. Average credit card APR is around 15%, so in most cases that 3% decrease is not enough to positively impact repayment. In general, you need an interest rate of 10% or less for consolidation to be effective – the lower, the better.

Term (length of repayment plan) matters, too. For the most part, term is inversely tied to monthly payments.

  • A longer term offers lower monthly payments, but increases total costs because there are more months to apply interest charges.
  • A shorter term reduces your total cost, but it increases the monthly payment requirement.

Comparing DIY solutions to credit counseling

If you’re not sure if a personal loan is the right choice compared to a Debt Management Plan, assess the time and total costs.

  1. How fast can you get out of debt with a loan versus a debt management program?
  2. Is the total cost lower or higher?
  3. What’s the difference in monthly payments

For people that have good credit, they can often use a loan to effectively eliminate debt. They can qualify for a low interest rate and then set the term based on what payments they can afford.

However, if you have bad credit, it’s likely that the total cost of a loan will be higher than what you can achieve with debt management. In this case, you’re often better off if you go through credit counseling.

Get a free evaluation to find the best way to consolidate.