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Debt consolidation is a strategy that involves combining multiple debts into one, typically through a loan or credit card balance transfer. Consolidating debts can help you simplify your monthly payments and potentially pay less interest.
Consolidation could make sense if you'd like to streamline your debt payoff. Understanding how it works, as well as the pros and cons, can make it easier to decide if debt consolidation is right for you.
Debt consolidation works by rolling multiple debts into one. Instead of having several debt payments to make each month, you would have just one to manage.
There are two primary ways to consolidate debt:
Debt consolidation loans allow you to borrow a lump sum of money, which you repay with interest. Rates are usually fixed, meaning they don't change for the life of the loan.
You use the loan proceeds to pay off debts that you want to consolidate. Going forward, you make one loan payment to the lender each month.
Credit card balance transfers work by letting you move balances from one card to another. You might pay a balance transfer fee, but many cards offer an introductory 0% annual percentage rate (APR). The promotional 0% APR is good for a set time, which may be anywhere from six to 21 months. You have that long to pay down your debt interest-free until the regular variable APR kicks in.
Consolidating debts can offer advantages and disadvantages. Here's a look at how they compare.
Loans let you borrow a lump sum for almost any purpose, including debt consolidation, and then pay it back. Some debt consolidation loans are unsecured, while others are secured, meaning you'll need collateral to qualify.
Personal loans for debt consolidation can allow you to borrow up to $100,000—typically at fixed interest rates. The benefit of a fixed-rate loan is that your payments will never change and you'll be able to calculate how much interest you'll pay in total.
If you're interested in a debt consolidation personal loan, you can find them at traditional banks, credit unions, online banks, and online lenders. When comparing personal debt consolidation loans, consider:
Personal loans for debt payoff are usually unsecured, meaning you won't need to offer anything of value as collateral.
A home equity loan uses your equity as collateral. Equity is the difference between what you owe on your home and what it's worth.
The amount you can borrow with a home equity loan can depend on how much equity you have, your credit scores, and your choice of lender. Rates are most often fixed and you may have up to 30 years to pay back a home equity loan.
If you have good credit you may be able to get a lower rate with a home equity loan than you would with a personal loan. There is one thing to keep in mind, however: If you don't pay a home equity loan back, the lender could attempt to foreclose on your home.
A home equity line of credit (HELOC) also uses your equity as collateral. The difference between a HELOC and home equity loan is that you're getting access to a revolving line of credit instead of a lump sum.
You can use your line of credit as needed to consolidate debts or cover other expenses. Interest rates are more likely to be variable, though some lenders do offer fixed-rate HELOCs. You only pay interest on the amount of your credit line you use, so your payments will likely be less than with a home equity loan.
It's not unusual to have a five to 10-year draw period, during which you can use your HELOC. Once the draw period ends, you'll enter the repayment period, which can last up to 20 years.
Consolidating debts can help your credit score in some ways but cost you points in others. It helps to know what you can expect if you decide to move ahead with debt consolidation.
Consolidating credit cards using a balance transfer or a loan can impact your credit in three key ways.
In terms of whether these impacts are positive or negative, hard inquiries can knock a few points off your credit score. However, inquiries only count toward credit score calculations for two years.
Adding a new credit card or loan to your credit mix can help your score if you're widening the gap between how much you owe and your total credit limit. Lower credit utilization can help your score overall.
Making on-time payments to a new loan or balance transfer can also help. Payment history is the most important factor in the FICO credit scoring model, followed by credit utilization. Paying late, on the other hand, could hurt your score in a big way.
Consolidating debts using a loan has similar credit score impacts. You'll have a new inquiry on your credit reports when you apply and paying on time consistently can help raise your score.
You'll also get the benefit of lower credit utilization if you're transferring credit card balances to a new loan. The main thing to keep in mind with both credit card transfers and debt consolidation loans is that you don't want to add to your debt.
If you use a loan to pay off credit cards, and then run up new balances on them, that can hurt your credit utilization. And if you take on too much debt you could struggle to keep up with payments, which could put you at risk of paying late.
Debt consolidation may be a better solution for some people than others. You might decide to consolidate your debt if any of the following apply to your situation.
There are two ways to get a lower interest rate when consolidating debt. You can apply for a 0% APR balance transfer credit card or get a low-rate personal loan.
Generally, you'll need good to excellent credit for either one. If you're confident you can secure a balance transfer offer or loan at the best terms, it could make sense to consolidate debts to save money on interest.
Consolidating debt could also be a smart move if you're tired of juggling several monthly payments. Moving all of your balances to a single credit card—or consolidating debts with a single loan—means you have fewer payments to worry about.
It's also easier to plan your monthly budget when payments are structured.
Say you get a 0% APR balance transfer card for 21 months. You have $10,000 to pay down. You can easily calculate how much you need to pay each month to clear the balance ($10,000/21 months = $476.19/month).
Personal loans have a set term and monthly payment. All you need to do is make the scheduled payment on time each month to see your balance go down.
Consolidating debt could help you pay off what you owe in less time if you're able to get better terms than what you're paying now.
For example, if you're paying off credit card balances at 0% all of your monthly payment goes to the principal. Without steep interest charges as an obstacle, you could pay it down to $0 at a faster pace.
Debt consolidation loans usually don't offer a 0% interest rate, but you could still clear debt sooner if you qualify for a lower rate.
Consolidating debts is not always ideal. Here are three scenarios where you may think twice about combining debts.
Debt consolidation doesn't guarantee that you'll get the best rates. If you have poor credit you may not qualify for a lower rate than you're already paying. In a worst-case scenario, the rate might be higher.
Saving money on interest might not be your only goal for consolidating debt. But it may not make sense to take a credit score hit by applying for a new loan or balance transfer if you wouldn't qualify for a favorable rate.
Fees can add to your total cost of borrowing or the amount you have to repay. There are several fees to watch out for when consolidating debt.
Shopping around can help you avoid these fees. Some credit card companies waive balance transfer fees if you complete the transfer within a certain period after account opening. And it's possible to find personal loans for debt consolidation with no fees of any kind.
Consolidating debt may do more harm than good if you've developed poor spending habits. You might move balances to a new credit card or pay them off with a loan, only to turn around and charge new purchases to your cards.
Now you have even more debt to pay. You could eventually find yourself caught in a cycle of debt if you're constantly shuffling balances around or taking out risky, high-interest loans to cover expenses.
Talking to a nonprofit credit counselor can help you evaluate whether debt consolidation is the right thing to do. A credit counselor can look at your finances and offer potential solutions, which may include a debt management plan, debt negotiation, or even bankruptcy in more serious cases.
Consolidating debt isn't that difficult. If you're interested in combining debts, here's how to do it step by step.
You'll first need to consider which debts you want to consolidate. Credit cards are an obvious choice but you could also consolidate:
Making a list of all your debts, including the interest rate and monthly payment for each, can help you decide which ones you want to consolidate.
Next, you'll need to decide how you want to combine debts. Again, the options can include:
A 0% APR credit card balance transfer could make sense if you only have credit cards to consolidate and you're certain you can pay the balance off before the promotional rate ends. If you need more time to pay you might consider a personal loan instead.
Using a home equity loan or HELOC to consolidate debts is risky since you're trading unsecured debt for secured debt. It’s best to consider these options only if you were already planning to borrow against your equity for something else and want to pay off other debts at the same time.
Once you know how you want to consolidate debt you can start the application process.
Applying for a credit card balance transfer is as simple as filling out an application online. You'll need to tell the credit card company some details about the balances you want to transfer, including the amount and the account number.
If you're applying for a debt consolidation loan you'll need to tell the lender how much you want to borrow. You may be allowed to choose a repayment term that best fits your budget.
After you're approved for a balance transfer or loan, the final step is to start paying down the amount you consolidated.
Your loan agreement should specify what you need to pay each month. If you've transferred balances to a credit card you'll need to calculate how much you should pay to clear the debt before the promotional rate period ends.
Remember, paying on time and avoiding any new debt are the best ways to make the most of a balance transfer or consolidation loan.
Qualifying for debt consolidation hinges largely on your credit scores. Lenders use your credit scores to measure risk. Specifically, they're looking at how likely you are to pay back what you owe.
These tips can help you improve your odds of getting approved for debt consolidation.
Payment history carries the most weight for FICO credit scoring. The simplest way to give your score a boost is to pay your bills on time.
You can ensure on-time payments by:
Late or missed payments can take up to seven years to fall off your credit report. The good news is that their negative impact on your score fades over time.
Whether you're interested in a credit card balance transfer or debt consolidation loan, it's important to compare offers. Specifically, you want to look for the best terms available for your credit profile.
If you know, for instance, that you have fair credit you may not want to waste time applying for loans with lenders that require a minimum credit score of 700 or better. Checking your credit before you apply can give you a better idea of which credit card offers or loans you're most likely to be approved for.
Your current bank may be a good place to start looking for balance transfer cards or debt consolidation loans. However, don't limit yourself to just one option.
Comparing terms and offers from other lenders can give you a better idea of what's available. Also, keep in mind that your current credit company may not allow you to transfer balances to a new card internally. So you may need to look for an issuer where you don't have cards for balance transfer offers.
Debt consolidation could save you money on interest or, at the very least, help you streamline your monthly budget. Comparing the different options for consolidating debts and the potential benefits can help you decide whether it's the right solution for your financial needs.
Debt consolidation loans let you borrow a lump sum and use the money to pay off existing debts, including credit cards, unsecured loans, and medical bills. You then repay the debt consolidation loan with interest, according to the payment schedule set by your lender.
A debt consolidation loan can ding your credit score slightly since applying for one usually involves a hard credit check. Over time, consolidating debt with a loan could help your score if you consistently pay on time and your overall debt balance decreases.
Debt settlement, also referred to as debt negotiation or debt resolution, allows you to pay creditors less than what you owe. Settling debts may be a realistic option if you've fallen significantly behind on payments, as your creditors might be willing to accept partial payment. Keep in mind that creditors are not required to agree to a settlement and may use other means, including a credit card lawsuit, to compel you to pay.
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