4 Useful Debt Reduction Strategies

All debt reduction strategies will come with advantages and disadvantages. Some, however, are more advantageous than others. It is best to attempt strategies that will not affect your credit first. Only attempt more drastic strategies if the reward is worth the cost or if you are facing default. In that case, debt consolidation or settlement may be an option.

#1 Buy Down

You may think paying down a large sum of your principal debt is the best use of your cash. For example, many borrowers spend their annual bonus salary by paying down principal. This will reduce your debt, but it may not make your payments any easier in the short run. Instead, consider buying down your interest rate. When you buy down your rate, you are paying a large chunk of your interest up front in exchange for a lower interest for a short period of time. The effect is relatively similar to the total cost of your loan. However, buying down a mortgage will actually make your monthly payments smaller. This can make your debt less burdensome for anywhere from one to three years. Buy downs are most common on mortgages.

#2 Refinance

Refinancing is a lot trickier than many lenders would have you think. First, you can refinance your loan direct with your current lender. This comes with the lowest amount of penalties, but your current lender has less incentive to offer you better terms than a third party does. A third party lender attempting to generate a new revenue source from your loan may offer much lower rates and more favorable terms. Unfortunately, this means you will have to prepay your existing debt, which can come with penalties. Prepayment fees are common on most forms of debt. Your credit may additionally drop if you refinance with a third party.

#3 Consolidate

Consolidation is a form of refinancing multiple debts at once. You can take a new, large loan that covers the prepayment quotes on all of your existing debt. Since refinancing results in some penalties, it makes sense that consolidating aggregates those penalties. In fact, you may even have more debt at the end of a consolidation program if you are not smart with your strategy. For consolidation to be effective, you should be able to negotiate very favorable terms on the consolidation loan that result in a much lower total cost than if you continued your current loans separately.

#4 Settle

Usually, consolidation and settlement come hand in hand. You are offering a lump sum to your lenders through consolidation, and this lump sum is usually offered in exchange for a reduction of debt. With settlement, you may not get a low quote unless you can prove your loan will go to default unless the lender takes the deal. For example, if you are about to enter a divorce proceeding, bankruptcy or another financially challenging period, a lender may be convinced it is best to simply take the lump sum today and allow the loan to be closed prior to any potential discharge or court ordered reduction.

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