Debt Consolidation vs. Refinancing – The Differences Explained
Consolidation and refinancing are two commonly-discussed debt repayment solutions. Though these terms are sometimes used interchangeably, there are some important differences between the two and considerations that go into choosing which one is best for you. Adding to the complication is that “consolidation” is often associated with credit card debt while “refinancing” is often used to describe a particular mortgage repayment strategy. In reality, most types of debt can be consolidated or refinanced. Each of these options may be a viable strategy for your credit card debt. Here is a closer look at the two approaches, with an emphasis on how you might use them for credit card debt.
Debt Consolidation
We have discussed debt consolidation quite a bit lately, including smart strategies you can use to consolidate debt and its impact on your credit score. Here is a quick refresher. Debt consolidation is the process of paying off two or more existing debts with a new debt, effectively combining the old debts into one new financial commitment.
As a simple example, imagine you have three credit cards: A, B, and C. Let’s say you open a new balance transfer credit card (we’ll call that card D). You can transfer the balances from card A, B, and C to card D—meaning that A, B, and C now have zero balances. Now, you will make payments toward card D, and that will be your only credit card obligation (assuming you close card A, B, and C or don’t use them). That’s consolidation.
Its primary benefit is that it simplifies repayment and makes your debt easier to manage. In our example, sending one payment each month would be easier than three. A secondary benefit is that consolidation can be used to get better terms on your debt, which makes repayment faster. For example, assume that card D had a promotional, zero-percent interest rate while cards A, B, and C had been racking up interest with rates over 15 percent. Just keep in mind that consolidation does not always get you better terms. It depends on your credit score and the purpose of your consolidation.
Refinancing
Refinancing is simply changing the finance terms on a debt obligation. Typically, this occurs by taking out a new loan or other financial product with the different terms. The most basic example is a mortgage refinance. There are different types of mortgage refinances, but we will focus on the “rate-and-term” refinance. This has been incredibly popular in recent years given the historically low interest rates that have been available. It works like this: let’s say a homeowner has a mortgage at 4 percent interest but wants to refinance to a lower rate, say 3.5 percent. The homeowner could basically take out a new mortgage to pay off the original mortgage. The new loan would have new terms, meaning a new interest rate (here it would be 3.5 percent) and potentially a new repayment period.
What about for credit cards? You do not hear about “refinancing credit cards” as often, but it is possible and quite common. It can be difficult to decipher the difference between refinancing credit card debt and consolidating it. The confusion comes from the fact that different industries, companies, and individuals use this financial vocabulary in different ways. For instance, some companies may refer to balance transfers as credit card refinancing, and will only use “debt consolidation” to refer to a strategy involving a consolidation loan.
But, that does not quite hold true. Balance transfers are often used to consolidate multiple debts. Instead, think of it this way: All consolidation involves refinancing, but not all refinancing involves consolidation. The primary distinction is based on the number of debts you have. You cannot consolidate a single debt, because you do not have other debts to combine it with. However, you can refinance it. On the other hand, if you move multiple debts into a new debt, you will have new repayment terms (meaning you refinanced) but you have also consolidated into a single debt obligation.
There is, arguably, one other form of refinancing. However, it does not adhere to the strict, traditional definition. As mentioned above, refinancing typically involves a new financial obligation that replaces an old obligation. However, it could also involve keeping the financial obligation you already have, but negotiating the terms. In the credit card context, you may be able to negotiate a lower interest rate on your credit card, for example. That is effectively a refinancing of the credit card debt without taking on a new debt.
One argument against considering this to be a “refinance” is that often the negotiated terms are temporary. Your creditor might lower the interest rate for a short period of time because of a hardship you are experiencing, but that is much different than agreeing to a fundamental change to the interest rate for the rest of your time as a card holder.
What About a Debt Management Plan?
You might think of a debt management plan (DMP) as combining the best features of consolidation and refinancing. A DMP does not technically consolidate your debts, but it allows you to pay one monthly payment for all your credit cards on the plan. You pay the credit counseling agency one payment, and they distribute that payment to your creditors. It also has the perk of a being an effective “refinance” because your debts are often charged lower interest rates while on the plan.
The Takeaway
The various terms used to describe debt repayment options can create some confusion. At the end of the day, the exact language does not matter as much as the outcome. Keep in mind that managing your debt is important and consolidating your payments may make the management easier. Also, the terms of your debt are important because they will affect how affordable the debt is and how quickly you can pay it off. There are a variety of repayment strategies that incorporate these variables. If you would like help thinking through the strategy that may be best for you, contact a credit counselor for free assistance.
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Do I have to close my cards to consolidate my debt?
Bruce McClary, NFCC December 7, 2020
The NFCC often receives readers questions asking us what they should do in their money situation. We pick some to share that others could be asking themselves and hope to help many in sharing these answers. If you have a question, Ask an Expert. This week’s question: When consolidating debt, do you require that cards be closed? Also, do you include items in collections when consolidating debt? The short answer: You are typically not required to close your accounts if you get a new loan to consolidate your debts. Traditional debt consolidation involves getting a new loan with a lower interest rate to pay off your debts, like credit cards and collections. If you use a consolidation loan to pay off your credit cards, you don’t have to close them, and you can certainly use those funds to pay your collections. Lenders issue consolidation loans and they are usually in the form of secured or unsecured loans. Secured loans use your assets, like a car or your home, to guarantee the loan and unsecured loans rely on your creditworthiness and good faith that you will pay it back. Debt consolidation is not the right strategy for everybody. If you don’t.
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Bruce McClary, NFCC January 12, 2021
The NFCC often receives readers questions asking us what they should do in their money situation. We pick some to share that others could be asking themselves and hope to help many in sharing these answers. If you have a question, please ask an expert. This week’s question: My current financial state gives me anxiety and I would really like to get it under control. I want to have financial freedom and peace of mind, but I don’t know where to begin. How should I start to tackle my debt? It takes a lot of courage to reach out and ask these tough questions. Finances often cause people anxiety and can especially be stressful if you are not sure how to tackle your debt. Take the First StepTake a deep breath and rest assured that you are already taking steps toward financial freedom by actively looking for a solution. And, yes, it can feel disheartening to think that your only way out is to get a consolidation loan with a lower interest rate, but the system won’t allow you to do so. It’s frustrating. However, it’s not as bad as you think. Loan consolidations are not always the best option, especially.
Credit Card Refinancing vs. Consolidation: What’s the Difference? While…
While both credit card refinancing and debt consolidation aim to alleviate financial burdens, they differ in approach and outcome. Refinancing involves transferring existing credit card debt to a new card with lower interest rates or obtaining a loan to pay off the debt, often leading to lower payments. Consolidation, on the other hand, combines multiple debts into one loan, potentially with a lower overall interest rate. Understanding these options is crucial for selecting the right strategy—be it a refinance personal loan or credit card debt refinance—to improve your financial situation.
How to Deal with High-Interest Rates When Refinancing
High-interest rates can be a significant burden when looking to refinance. To combat this, start by shopping around for the best refinancing offers. Consider credit unions and online lenders, which often provide competitive rates. Negotiating with current lenders for a lower rate can also be effective, especially if you have a history of timely payments. Additionally, improving your credit score can open the door to better rates. Tackling high-interest rates head-on can lead to substantial savings over the life of your debt.
The Changing Landscape of Credit Scores and Refinancing Eligibility
The landscape of credit scores and refinancing eligibility is evolving, with lenders increasingly considering alternative data and metrics beyond traditional credit scores. This shift aims to provide a more holistic view of a borrower’s financial health, potentially opening up refinancing options to a broader audience. Innovations in credit reporting, including the consideration of rent, utility payments, and banking behavior, are reshaping how creditworthiness is assessed, making refinancing accessible to those who may have been previously overlooked based on traditional criteria.
The Insider’s Guide to Negotiating Lower Interest Rates
Negotiating lower interest rates on your debt can significantly impact your refinancing strategy. Start by understanding your current financial standing and the market rates. Armed with this knowledge, approach your lender to discuss your situation and request a rate reduction. Highlight your payment history and credit score improvements. Lenders are often willing to negotiate to retain customers. Remember, persistence and preparation are key. Successfully negotiating lower rates can save you thousands over the life of your loan, making it a critical tactic in effective financial management.
Strategies for Paying Off High-Interest Credit Cards Through Refinancing
Refinancing high-interest credit cards involves strategies like obtaining a lower-interest personal loan, transferring balances to a lower-rate card, or consolidating debts. The key is to secure a refinancing option with significantly lower interest rates than your current cards. Prioritize loans or cards that offer the most favorable terms and commit to a repayment plan that accelerates debt reduction. By strategically refinancing your high-interest credit cards, you can save on interest payments and expedite your journey to becoming debt-free.
What to Expect During the Credit Card Refinancing Process
The credit card refinancing process involves several key steps: application, evaluation, and offer review. After submitting your application, lenders will assess your financial situation, including your credit score, income, and existing debt. This evaluation determines your eligibility and the terms of the offer. Expect to provide additional documentation or clarification if requested. Upon approval, you’ll receive an offer detailing the interest rate, terms, and conditions. Understanding this process helps set realistic expectations and prepares you for successful refinancing of your credit card debt.
Lessons Learned: Insights from Failed Refinancing Attempts
While not every refinancing attempt ends in success, there are valuable lessons to be learned from those that fall short. Common pitfalls include not thoroughly comparing rates, overlooking fees, or underestimating one’s financial stability. These insights from failed attempts underscore the importance of comprehensive preparation and understanding the refinancing process. Learning from these experiences can guide individuals towards making more informed decisions in future refinancing efforts, ultimately leading to better outcomes.
Investing in Your Future: Savings Strategies After Refinancing
Refinancing can free up additional funds through lower monthly payments. Investing these savings into your future is a wise strategy, whether through retirement accounts, education funds, or other investment vehicles. Start by setting clear financial goals and exploring various savings options to maximize returns. Consistent investment, even in small amounts, can yield significant long-term benefits, helping you build wealth and secure your financial future. This approach not only enhances your current financial situation but also ensures you’re better positioned for upcoming financial milestones.
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