Debt consolidation could be a good idea if you have high-interest debt, perhaps from credit cards, and can combine debts into a single account with one affordable monthly payment. You might be able to simplify the debt payoff process and in turn, improve your finances.
However, whether debt consolidation is a good idea depends on your situation. You might prioritize consolidating if you can secure a straightforward repayment plan with a more helpful lender. But if you can’t qualify for a lower interest rate, consolidation might be unwise because it could increase the cost of your repayment.
What is debt consolidation?
Debt consolidation is when you roll multiple debts into a single payment. It can make it easier for you to manage several debts and potentially lead to lower interest rates, lower monthly payments or a faster payoff.
You can consolidate various unsecured consumer debts, such as credit cards, medical bills, payday loans and student loans. If your debts are of the same type, you might consider credit card refinancing, personal loan refinancing or student loan consolidation.
How does debt consolidation work?
The most common way to implement this strategy is through applying for a personal loan, also known as a debt consolidation loan.
Related >> The best debt consolidation loans
Once you receive a lump sum of cash from your lender, you’ll put it toward all your debts. Then, you’ll make one monthly payment on your new loan. Note that some lenders will repay your creditors directly so you don’t have to.
Besides personal loans, there are other ways to consolidate debt, including:
| Method | Good for… | How it works |
|---|---|---|
Balance transfer credit card | Borrowers with considerable savings, strong cash flow and credit | You would pay off your existing debt with the balance transfer card — and then pay off that card before its 0% introductory APR period expires. The best balance transfer cards have a no-interest period spanning 12 to 21 months. |
Home equity loan, line of credit | Creditworthy homeowners who’ve made a dent in their mortgage | Home equity loans and lines of credit can be used to pay off all sorts of debt. A line of credit offers more flexibility for responsible borrowers because you can draw funds as needed. |
Is debt consolidation a good idea?
If you’re overwhelmed by multiple debts, debt consolidation might be a good idea. This is particularly true if you can land a lower interest rate than the average rate you pay on your current debts. The lower your rate, the greater your savings.
The average rate for a 24-month personal loan stood at 12.49% in February 2024, according to Federal Reserve data.
Example: Let’s say you owe $20,000 in credit card debt and $10,000 in personal loan debt with an average interest rate of 16%. Consolidating these debts with a $30,000 personal loan with a 10% interest rate could save you thousands of dollars in interest, depending on your original and new repayment terms. Try a debt consolidation calculator like Calculator.net’s to estimate your potential savings.
Expert’s take: “The amount [that] debt consolidation can save you depends on various factors, such as the interest rates of your current debts, the terms of the consolidation loan and your ability to make consistent payments,” said Jeffrey Wood, a certified financial planner and certified public accountant. “In general, if you can secure a consolidation loan with a lower interest rate compared to the average rate of your existing debts, you may save money over time. Additionally, if the consolidation loan extends the repayment period, your monthly payments may become more manageable.”
However, this strategy may not make sense if you only have a small balance and can pay it off quickly. For example, if you owe $1,000 in credit card debt and have no other type of debt, consolidating is unlikely to be right for you. With some planning, you should be able to zero your credit card balances fairly quickly.
Consolidating may not be the solution, too, if your unsecured debts are the result of poor spending habits and a lack of budgeting. Instead of pursuing consolidation right away, you might be better off creating a budget or spending plan to avoid abusing the plastic in your wallet.
Related >> How to get out debt
When should I consolidate my debt?
You might consider debt consolidation in the following scenarios, according to Trinity Owen, a National Financial Educators Council-certified instructor and financial literacy professional.
You’re overwhelmed by various debts
Making various payments to various creditors — and tracking your progress toward erasing each balance — can understandably cause stress. “If you miss any of (your) due dates, you could face late fees, not to mention the potential negative impact on your credit score,” said Owen. “Debt consolidation can simplify the debt payoff process.”
Your current interest rates are high (or variable)
If you're dealing with debts that carry high rates, you're likely seeing a significant portion of your monthly payment get eaten up by interest charges rather than reducing your actual debt balance. Similarly, if you have variable rates on your existing debts, you might be wary of rising rates putting your budget at risk.
If you consolidate your high-interest debts into a single loan with a lower, fixed interest rate, more of your monthly payment will go toward paying down the principal balance. And you’ll enjoy more consistency with your budget.
You thrive on a straightforward payment plan
If organizing your debt — and setting a payoff goal — will make it easier to wrap your head around repayment, debt consolidation could be smart. “It’s particularly beneficial if you're dealing with credit card debt, which often has open-ended repayment schedules that can make it difficult to see the end in sight,” said Owen.
You’re at risk of missing payments
Debt consolidation can be a good idea if you’re having a tough time juggling your financial obligations. Consolidating can put your debt in one place, so you have a single monthly payment. That might help you stick to your repayment schedule and avoid any adverse consequences.
What are the consequences of missed payments?
When you miss or make late payments, it can have a domino effect. It harms your credit scores, and you could be hit with late fees and penalties. If you consolidate with a secured personal loan and fall behind on repayment, your collateral could also be at risk of eventual seizure.
“Additionally, if you default on the consolidation loan, you may face legal action from the lender,” said Wood.
Missing payments can tarnish your credit reports’ payment history. Among all the factors considered in your credit scores, payment history has the largest influence, making up 35% of your credit scores, according to FICO. Be aware that late payments are generally reported to the major credit bureaus after 30 days and can remain on your credit reports for seven years.
A drop in your credit scores can make it more difficult to get approved by lenders for future credit. So, if you need a mortgage or auto loan in the future, your approval odds may be lower or you may only get approved with a higher interest rate.
When is debt consolidation not a good idea?
Debt consolidation isn’t right for everyone. Owen suggested you avoid it if you’re in either of the following situations.
You can’t land a lower interest rate
When considering a debt consolidation loan, it's crucial to compare the interest rate of the potential new loan with your current rates. If the consolidation loan's interest rate is higher, you’ll likely end up paying more in interest over the life of the loan. This would make your overall debt more expensive in the long run.
The upfront costs wipe out your potential savings
Some debt consolidation lenders might charge:
- Origination fees (0% to 12% of the loan amount)
- Prepayment penalties (rare among personal loan lenders)
- Balance transfer fees (3% to 5% of the transferred amount)
- Closing costs
These added fees can make debt consolidation more expensive. Ask prospective lenders about all fees and read the fine print before consolidating your debt.
You have unhealthy spending habits
Consolidating your debt doesn't necessarily address any underlying issues that may have contributed to your debt in the first place. For example, if you have a habit of overspending or living beyond your means, consolidating your debt won't solve these problems. Try to address them head-on before you decide whether to consolidate.
Pros and cons of debt consolidation
Consider whether the pros of consolidation outweigh the cons for your circ*mstances.
| Pros | Cons |
|---|---|
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5 alternatives to debt consolidation loans
1. Debt snowball or debt avalanche
Good option if you’re seeking a “DIY” debt repayment strategy.
Debt snowball and debt avalanche are two debt repayment methods that don’t require hiring a professional or applying for a new loan or credit card. With the debt snowball strategy, you pay off your smaller debts first and then “roll” the amount you used to pay for them into paying off larger ones (creating a “snowball effect”).
If you’re having trouble staying motivated during debt repayment, the debt snowball method is likely your best bet. Debt avalanche is when you pay off your highest-interest debts first — this strategy can save you the most on interest but lacks the quicker, smaller wins.
2. Balance transfer credit card
Good option if you have good to excellent credit.
With a balance transfer credit card, you can repay debt without interest charges during an introductory period, which may be between 12 and 21 months. If you go this route, you’ll be on the hook for a balance transfer fee of 3% to 5% of the amount you transferred.
Also, if you don’t pay off the full debt by the time the intro period is up, you’ll be charged a typical double-digit APR on your balance. It’s a good idea to shop around and compare the best balance transfer cards so you can zero in on the right card for your particular situation.
3. Home equity loan or HELOC
Good option if you’re a homeowner with sufficient equity.
A home equity loan or home equity line of credit (HELOC) allows you to borrow money against the equity you’ve built in your home. While a home equity loan offers a lump sum of cash upfront at a fixed interest rate, a HELOC is a credit card-like revolving line of credit (with variable rates) that you can withdraw funds from at any time, up to your set credit limit.
You can usually borrow up to 85% of your equity, but requirements vary by lender. Note that since a home equity loan or HELOC is secured by your home, the lender may foreclose on your property if you default during repayment.
Related >> The best rates for: Home equity loans | HELOCs
4. Debt settlement
Good option if you have significant debt and are struggling with payments.
During debt settlement, you negotiate with lenders to pay less than you owe. You can go through this process on your own or contact a reputable debt settlement company. For the latter, consider accredited members of the American Association of Debt Resolution. (Be wary of companies that charge upfront fees, offer guarantees or push you to move quickly.)
Keep in mind that even if you hire a debt settlement company (or attorney), you’ll be charged a fee of between 15% and 25% of your debt, with no guarantee that the negotiations will be successful. For this reason, attempting a settlement may only make sense if you have significant debt (five figures or more) and want to avoid bankruptcy.
5. Bankruptcy
Good option if you’ve exhausted all other debt relief options.
Bankruptcy is a legal process that can help you find relief from an overwhelming amount of debt. The two types of consumer bankruptcies are Chapter 7 and Chapter 13, and the right one depends on your particular situation.
If you have limited income and can’t repay at least some of your debts, Chapter 7 bankruptcy or “liquidation bankruptcy” might make sense. This is where you sell most or all of your non-exempt property to pay off unsecured debts like credit card debt and medical bills. When the process is complete, the remainder of your eligible debt will be erased (but certain types of debts like child support, student loans, most tax debts or legal penalties may be more difficult or impossible to discharge).
You may qualify for Chapter 13 bankruptcy (or wage-earners bankruptcy) if you have a higher income. It consists of a three-to-five-year repayment plan where you’ll repay all or a portion of your debts. As long as you follow the repayment plan as prescribed by the courts, your remaining eligible balances will be discharged at the end of the program.
Since bankruptcy can take a huge toll on your credit for seven to 10 years, it should be used as a last resort. Before you consider filing for bankruptcy, talk to a certified credit counselor about your options, including a debt management plan. The Department of Justice maintains a list of approved counseling agencies.
How does debt consolidation impact my credit scores?
A debt consolidation loan can help or hurt your credit scores at various junctures:
When you apply
In most cases, debt consolidation means borrowing a new personal loan or opening a new credit card, which will require a hard inquiry by the lender. The lender will use the hard inquiry to understand your creditworthiness and determine whether to approve your application. A hard inquiry can temporarily drop your credit scores by up to five points, according to FICO.
Related >> What to know about personal loan pre-qualification
When you make payments
As you make timely payments on your loan or credit card, your credit scores will likely improve, as long as the lender reports to the national credit bureaus (Equifax, Experian and TransUnion). On the flip side, late or missed payments will lower your credit scores and make it difficult to get approved for other financing products with favorable terms.
How to consolidate your debt
If you’re interested in debt consolidation, consider common personal loan requirements and follow these steps.
- Check your credit: Checking your credit can serve two purposes: Help you identify errors on your credit reports that might be weighing down your credit scores and set the expectation of the type of interest rate you may qualify for (typically the lowest interest rates are reserved for applicants with good to excellent credit scores). Visit AnnualCreditReport.com to pull free copies of your credit reports and dispute any errors. Also, check your credit scores so you know what type of loans and interest rates you might qualify for. You can access a FICO credit score at Experian, plus some banks may offer access to a free FICO score.
- Jot down your debts and payments: Make a list of all the debts you might consolidate, including credit cards, medical bills, payday loans, store cards and any other high-interest debts. Then, add them up so you know how much debt you have and how large of a debt consolidation loan you need.
- Shop around: Debt consolidation loans can be found at many banks, credit unions and online lenders. Since they’re not created equal, compare the rates, terms and fees of each of them so you can make the most informed decision. Start with financial institutions that offer prequalification — that is, the ability to confirm eligibility and check rates without adhering to a hard credit check.
- Complete an application: Once you’re ready to apply for a debt consolidation loan, fill out the application online or in person. Be prepared to submit documents like your ID and paystubs. If you apply with multiple lenders, do so within 14 days to lessen the impact on your credit scores.
- Close the loan and make payments. If the lender pays your creditors directly with your debt consolidation loan funds, make sure they’ve been repaid. If the lender doesn’t make direct payments to creditors, use the loan proceeds to repay each debt individually. Then, begin making payments on your newly consolidated account.
Tips for managing a debt consolidation loan
If you decide to move forward with a debt consolidation loan, consider this advice:
- Create a budget. Design a realistic budget that includes your loan payment as well as other monthly expenses, like your rent or mortgage, utilities and groceries.
- Open another bank account. “I often advise clients to have a separate bank account where they can deposit the money they are using for the consolidation loan payoff and to not touch the account other than to make their loan payments,” said Derek Jacques, a Michigan-based bankruptcy attorney.
- Set up automatic payments. “It’s a good idea to enroll in autopay so that you don’t miss any repayments and bring down your credit score,” said Taylor Kovar, a Texas-based certified financial planner.
- Consider refinancing. Even if you consolidate once, it could make sense to repeat the process in the future, particularly if you can refinance to a lower interest rate, said Jacques.
Additional reporting by Melanie Lockert
Frequently asked questions (FAQs)
Applying for a debt consolidation loan involves a hard credit inquiry. This may stay on your credit report for about two years.
After you’ve borrowed a debt consolidation loan, it will stay on your credit reports until you’ve repaid it. Making on-time payments toward the account should improve your credit scores over time. Alternatively, if you miss a monthly payment, the delinquency can hamper your scores and stay on your credit reports for up to seven years.
Consolidating debt has the potential to lower your credit scores, at least temporarily. This is because a debt consolidation loan requires a hard inquiry into your credit history.
Consolidating could also decrease your credit scores because it would lessen the average age of your credit accounts. After all, you’d be replacing older debt accounts with one new loan.
Most lenders offer debt consolidation loans to borrowers with good to excellent credit scores, which fall in the 670 to 800-plus range. But you may be able to land one with a poor or fair credit scores between 300 and 669, particularly if you apply with the backing of a creditworthy cosigner or co-borrower.
If you do get approved for a loan with a shaky credit history, be careful as not all lenders are reputable, and you could be charged a high interest rate. The higher your credit scores are, the better your chances of securing an attractive interest rate with a highly-rated lender.
