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Can You Consolidate Your Debt With Bad Credit?

Gerri Detweiler

When you’re struggling with debt, you look for any lifeline you can find. A debt consolidation loan may be one of them. But can you get one when you need it? A Credit.com blog reader asks:

Are there any second-chance lenders and debt consolidation loans/investors out there w/low rates for folks with really bad and now worsening credit?

The challenge is that when you need a consolidation loan it can be hard to get one. Why? Because lenders will take into account your current debt, which is, of course, the reason you need one of these loans! Lenders may consider your debt in a couple of ways:

Debt to Available Credit: A prospective lender will no doubt request a credit score and the debt you carry is one of the main factors used in calculating credit scores.  Virtually all credit scoring models take into account the amount of your revolving balances in comparison to your available credit limits. The closer your balances get to your credit limits (known as “utilization”), the more this factor will hurt your scores. If you are nearly maxed out on one or more credit cards, your credit scores have no doubt taken a hit. Want to see how your utilization is impacting your credit scores? You can check two of your credit scores for free and get a personalized action plan for building your credit on Credit.com.

Debt-to-Income Ratio: Lenders will ask about your income in your application and typically compare your monthly payments on all your debts to your income. In addition, they may take into account the payment on the new debt as well. Even though your plan may be to use the new loan to pay off your other debts, and then pay the new loan off as fast as you can, the new lender is wondering what will happen if you consolidate and pay off your credit cards, and then run up new balances.

In addition to your debt, your payment history will be a major factor in terms of whether you get approved. If your credit reports list late payments or other negative items like bankruptcy — especially in recent years — it will be harder to get the loan you need.

Improve Your Odds

To increase your chances that you are able to get a consolidation loan, you will want to first check your credit reports and credit scores to see where you stand. The stronger your credit, the easier it will be to get a consolidation loan with a decent interest rate.

Finding one of these loans can be tough. A lot of the ads you see for consolidation refer to home equity loans (which won’t work if you don’t have a lot of equity in your home), payday-like loans that carry high interest rates, or for companies that don’t really make these kinds of loans but instead help consumers get out of debt through debt negotiation or credit counseling. (More about that in a minute.) Your local bank or credit union might offer this type of loan, or it might not.

Another option is to shop for a personal loan online. Just make sure you are dealing with a reputable company and/or website, since there are a lot of cyberscams designed to get your personal information. Look for a secure site that has been in business a while and has a good reputation.

Have a Plan B

If you can’t qualify for a consolidation loan, then you may want to consider a couple of other options to get out of debt.

One is to borrow against your retirement plans. If you have substantial savings in a 401(k) or a 403(b) plan you may be able to borrow against these funds. This option is fraught with risk, including the risk that you won’t be able to pay back the loan and wind up paying steep taxes and penalties.  So it is not to be considered lightly by any means. But because there is no credit check required, your current debt won’t be a consideration. (Of course, the ease of getting one is one of the problems!)

A more realistic choice is to a Debt Management Plan through a counseling agency. If you enroll in one of these plans, you’ll only have to make one payment a month to the counseling agency which, in turn, will pay all your participating creditors. Interest rates are often reduced, as is the monthly payment. And best of all, enrolling in a DMP doesn’t require good credit. In fact, no credit check is required.

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