What is the best way to consolidate debt?

Debt consolidation is a bad idea if it does not save you any money. This happens when the interest rate on your new loan or line of credit ends up being higher than that of your existing debts, which mostly defeats the purpose of consolidation. In that case, the only benefit would be having all your debts in one place. Debt consolidation may be a bad idea in other situations too, like if you work with a misleading company or consolidate right before a major purchase.… read full answer

When Debt Consolidation Is a Bad Idea

• When the APR is higher than on your existing debts
• When your "debt consolidation" service is really debt settlement
• When you're about to buy a house or car

If your credit score is worse than when you originally took out your existing debts, it will be hard for you to find a consolidation loan with a good rate. It's a good idea to check your credit score before applying for any debt consolidation loan and to spend a few months improving your credit score if needed.

But even if your credit score is in good shape, you still have to watch out for the wrong types of companies, as well as make sure there aren't any major purchases in your near future.

Debt Settlement Services Disguised as Debt Consolidation

One major situation where debt consolidation is a bad idea is if you're using a "debt consolidation" service that actually turns out to be a debt settlement company instead. Rather than negotiating for a lower interest rate, debt settlement companies try to get your issuer to accept a lump sum and forgive the rest of your balance.

The problem is that debt settlement is a negative item that remains on your credit report for 7 years. In addition, debt settlement companies often have you avoid making payments to the lender for a while to get better negotiating power. That's very bad for your credit score, too. On top of all that, debt settlement companies can charge expensive fees.

Debt Consolidation Before a Large Purchase

Debt consolidation is a bad idea if you're about to buy a house or a car. Getting a debt consolidation loan or line of credit will damage your credit score in the short term because of the hard credit pull triggered by the application. Working with a debt consolidation company also damages your credit if you default during negotiations.

If you're about to make a major financial decision that requires a credit check, you want your credit to be as good as possible. However, at other times, debt consolidation can be a good idea. The credit score damage from applying for a debt consolidation loan is usually limited to 5 to 10 points, which you can rebound from after a few months of on-time payments.

You can predict how debt consolidation might impact your credit score by using WalletHub's free credit score simulator.

The biggest pros of debt consolidation include the potential to save a lot of money and the simplicity of having fewer monthly payments to deal with. Notable cons include short-term credit score damage, the possibility of fees, and the risk of actually adding to your debt load in the long run. Plus, it’s difficult to get a good deal on debt consolidation without a credit score of 660-700 or higher.… read full answer

So, the practice of debt consolidation does indeed have both pros and cons. But the pros usually outweigh the cons, especially for people who do their research and borrow responsibly.

Top 4 Pros and Cons of Debt Consolidation

Pros of Debt Consolidation:

1. Lower APR possible. When you consolidate, you may be able to get a lower APR than the ones on your original debts, which can save you money and help you pay off the total amount more quickly.
2. One monthly payment. You will go from having multiple monthly payments to keep track of to having just one.
3. Lower likelihood of default and credit score damage. Accruing interest less quickly and only having to submit one payment help reduce the odds that you will miss payments or default. Thus, you can avoid credit score damage.
4. More time for repayment. Depending on the type of debts you consolidate, you might get a longer payoff period. For example, if you consolidate payday loans, you’ll go from owing the money in 2 - 4 weeks to having months or years to pay it off – and at much lower rates, too.
5. Could free up collateral. If you consolidate with an unsecured loan or use a credit card balance transfer to pay off a loan that’s currently secured by collateral, you will no longer be in danger of losing that collateral.

Cons of Debt Consolidation:

1. Credit score restrictions. In order to qualify for a personal loan, you’ll need a credit score of 585+. You’ll need 620+ for a home equity loan or HELOC and 700+ for a good balance transfer credit card. And those are the bare minimums – you’ll need good or excellent credit for the best APRs.
2. Lower APRs aren’t always available. Not everyone can qualify for a lower APR than they currently have, especially if their credit rating has declined since they took out the original debt.
3. Not all debts are eligible. Not all debt consolidation options support all types of debt. For example, credit card issuers often limit the types of debt that can be moved to a credit card through a balance transfer.
4. Hard inquiries hurt your credit standing. If you open a new loan or credit card, the hard inquiry triggered by the application will cause some temporary credit score damage. It’ll take a few months of timely payments to bounce back.
5. Fees could add to your costs. You may need to pay a fee in order to consolidate debt. For example, personal loans sometimes charge origination fees of 1% to 8% of the loan amount, and credit cards often charge balance transfer fees of 3% to 5% of the transferred amount.
6. Consolidation might not solve your problem: If you don’t pay the bills on schedule and adjust your everyday spending to ensure it’s sustainable, consolidation won’t pay off in the long run. That’s especially true given that it might be possible to borrow more than the amount being consolidated. Your highest priority should be getting debt-free, so you don’t need to keep refinancing over and over.

There are plenty of ways to consolidate debt, each of which has its own pros and cons. You can consolidate by getting a lump sum through a personal loan or home equity loan. Or, you can borrow up to a certain limit any time you want by taking out a home equity line of credit or doing a balance transfer to a credit card.

Advantages & Disadvantages of Popular Debt Consolidation Options:

Personal loans allow you to borrow a lump sum for 12 - 84 months without putting down any collateral. Their funds can be used for anything, including paying off old debts.

Benefits of consolidating debt with a personal loan include quick funding and not having to put down collateral (usually).

Drawbacks include APRs as high as 36% and origination fees in some cases.

Home equity loans allow you to borrow a portion of the value of your house minus what’s still due on the mortgage. You can use the money for anything.

Benefits of consolidating debt with a home equity loan include potentially large amounts of funding and low APRs.

Drawbacks include using your house as collateral and sometimes having to wait over a month for funding.

Home equity lines of credit (HELOCs) allow you to borrow money multiple times up to a certain credit limit, based on your home’s value. Like home equity loans, you can use them to pay off debts.

Benefits of consolidating debt with a HELOC include potentially large amounts of funding, low APRs, and the ability to borrow multiple times.

Drawbacks include using your house as collateral and sometimes having to wait over a month for funding.

Balance transfer credit cards allow you to pay off multiple lenders with the card’s credit line, thereby moving the balances so that payments are due to the card’s issuer.

Benefits of consolidating debt with a balance transfer credit card include potential 0% APRs for 6 - 24 months and instant funding once you have the card.

Drawbacks include high regular APRs and often low credit limits.

Debt consolidation is a good idea for borrowers with high-interest debts owed to multiple lenders. Whether or not debt consolidation is wise depends largely on if you can get a new loan or credit card that will save you money compared to the current cost of your debts. The simplicity of a single payment can be helpful, too.… read full answer

How Much You Can Save With Debt Consolidation

* Interest rates are from WalletHub data and total interest is calculated on a 2-year basis.

When Debt Consolidation Is a Good Idea

When it gets you lower rates

If you’re able to qualify for a new loan or line of credit with a lower APR than your current creditors are charging, consolidating the debts will reduce the overall cost of what you owe by slowing down the rate at which interest accrues. That in turn will help you pay off what you owe more quickly.

When you’re having trouble managing your payments

If you find yourself with too many individual debts that are hard to keep track of, and you risk missing monthly due dates as a result, consolidating can help simplify your finances.

When the fees aren’t excessive

If you have a credit score of 660+, you should be able to qualify for a personal loan with no origination fee. And some balance transfer credit cards for scores of 700+ have no balance transfer fees. Other loans and cards may charge fees that increase what you owe by 1% to 8%, which might make debt consolidation a bad idea.

When you can get enough funding

Depending on how much you owe and how high your credit score and income are, you might not qualify for a large enough loan or credit limit to accommodate all your existing debts. In that case, you might consider consolidating partially, or you might decide that opening a new account isn’t a good idea.

When you’re not about to make a major financial decision

In the long run, debt consolidation can help you get debt-free more quickly and raise your credit score. But it will cause short-term credit score damage from the hard inquiry required to open a loan or credit card. This could affect your approval odds or the rates you get for things like auto loans or mortgages for up to a year.

Bottom Line

In conclusion, debt consolidation is a good idea when it helps you get organized and obtain better rates. You can click on the button below to compare the best debt consolidation loan offers on WalletHub.