Debt consolidation means paying off multiple debts with a single loan or line of credit, allowing the borrower to make just one payment per month on the total amount they owe. Debt consolidation does not reduce the amount you owe, but it should result in you paying less interest in the long run, if done right. Another benefit of debt consolidation may be a lower monthly payment achieved through a reduced interest rate, a longer repayment period, or both.
There are many ways to consolidate debt, including with a personal loan or a balance transfer credit card. Each debt consolidation method has its share of advantages and pitfalls, though.
Debt Consolidation Options
- Personal loans and lines of credit
- Home equity loans and HELOCs
- Credit cards
- Debt consolidation companies
One of the best ways to consolidate debt is with a personal loan, and you can check out your options with WalletHub’s free pre-qualification tool. It will tell you which lenders are likely to approve you for a loan and what rates you’re likely to get if approved.
Types of Debt Consolidation
Debt consolidation is a rather broad term, and the process can take on a number of different forms as a result. It is important to understand and consider all of your options prior to moving forward with any particular plan.
While certain loans are branded as being specifically for debt consolidation, the truth is that you can use any type of personal loan to pay off other amounts owed, which consolidates your debt. You just need to get approved for a big enough loan with a low enough rate and the right repayment period to make the transaction worthwhile.
Homeowners can take out a second mortgage, a home equity loan, or a home equity line of credit (HELOC). This basically entails using the equity you have amassed in your home as collateral for money that can be used to pay off other debts.
Home equity debt consolidation is often cheaper than taking out a personal loan, but it also has the significant downside of risking foreclosure if you cannot repay what you owe.
Credit Card Balance Transfer
Balance transfers are pretty much synonymous with debt consolidation. The issuer of the credit card to which you are transferring a balance will pay off what you owe the original lender, and take ownership of your debt. You will then be responsible for paying the credit card issuer back. This debt consolidation method is most worthwhile if you can get a 0% balance transfer credit card and then pay off what you owe before regular interest rates kick in.
You can actually transfer most types of debt to a credit card, including debt from other credit cards, store cards, auto loans, student loans, mortgages, HELOCs, small business loans and payday loans. However, not all credit cards will allow you to transfer all types of debt, so it’s important to ask the issuer what types they allow beforehand. Another key thing to note, which many people don’t know, is that you can actually transfer multiple balances from various lenders to a single credit card at the same time.
Debt Consolidation Companies
Debt consolidation companies are businesses that help people combine existing debts, whether through a program that negotiates a new deal with a borrower’s existing creditors or through a new loan or line of credit. Businesses that explicitly call themselves debt consolidation companies typically offer plans where they work with clients’ existing creditors to get better rates. The client makes a single payment to the debt consolidation company each month, and the company distributes it to the creditors.
You should also know that some companies calling themselves debt consolidation companies actually offer debt settlement. Debt settlement is different from debt consolidation in that the company negotiates a lump sum payment of a portion of your debt while the rest is forgiven.
Best Debt Consolidation & Settlement Companies
Banks, credit unions and online lenders that offer loans and lines of credit don’t call themselves debt consolidation companies. But they count because their products can be used to consolidate debt. The best lenders for debt consolidation offer low interest rates and fees, and some are able to directly pay off your old debts so you don’t have to.
Best Debt Consolidation Loan Companies
People looking for debt consolidation companies might also come across credit counseling organizations, which are non-profit organizations committed to helping indebted consumers improve their finances. More than anything else, they provide guidance and support, educating people about their options as well as potential pitfalls. Some may even represent you in negotiations with lenders.
Pros & Cons of Debt Consolidation
|Lower interest rate||Fees|
|Longer payoff period||Not guaranteed to get a lower rate|
|Only one monthly payment||Doesn’t treat the root cause|
|Improve credit long-term||Can hurt credit short-term|
|Info||May not be available|
Pros of Debt Consolidation
- Lower interest rate: Ideally, debt consolidation will bring down your interest rate. A lower interest rate means more money paying down the principal each month. If you also keep your monthly payment the same, you’ll pay down your debt faster and save money in the process.
- Longer payoff period: You may be able to choose to have a longer payoff period on consolidated debt than you had originally. While you’ll owe more interest this way relative to a shorter payoff period, stretching out your loan with lower monthly payments can help you avoid defaulting.
- Only one monthly payment: Consolidating all your debt in one place means you only have to pay a bill once a month. That in turn makes it easier to stay organized and avoid missing payments because of forgetfulness.
- Improve credit long-term: Debt consolidation, if done right, should make it easier for you to stay current on your payments and get out of debt sooner. And in the long run, your credit score should rise because of on-time payments and reduced debt. You can track your progress and get personalized suggestions on how to improve your credit score by joining WalletHub for free.
Cons of Debt Consolidation
- Fees: Whether you consolidate debt through a loan, a line of credit, a credit card or a debt consolidation program, you’re likely to owe some fees. For example, the average balance transfer fee on a credit card is around 3% of the amount transferred.
- Not guaranteed to get a lower rate: If you can’t qualify for a new interest rate that’s lower than the rates on your existing debts, there’s no point in consolidating your debts.
- Doesn’t treat the root cause: Debt consolidation can free up existing credit lines, which can be harmful if you immediately choose to rack up a lot more debt. Making sure you are responsible with future spending is just as important as taking care of the existing debts.
- Can hurt credit short-term: Debt consolidation may hurt your credit short-term due to hard inquiries on your credit report. In addition, if you enroll in a debt consolidation program, they may have you withhold payments from your creditor until they can negotiate a new deal. This can result in credit score damage until they reach an agreement.
- May not be available: Debt consolidation may not be possible if your debt problems have already damaged your credit standing significantly or your debt-to-income ratio is so high that no one wants to approve you for additional credit. If you fall into one of these categories, you may want to look into debt management, debt settlement, or – as a last resort – bankruptcy
Debt Consolidation Alternative
- Debt Management: Debt management involves negotiating a payment plan with your creditor in order to get a lower monthly payment, stay current on your bill, and eventually get back on track. Lenders won’t always offer a plan that works for you, however, so make sure to only sign an agreement where you’ll be able to keep your end of the bargain. For more information, check out WalletHub’s Debt Management Overview.
- Debt Settlement: Debt settlement is when a lender forgives a portion of your debt in return for you making a lump-sum payment for the remaining balance. Debt settlement can save you a lot of money, but lenders typically won’t even consider it unless you have defaulted or are close to defaulting on what you owe. It’s important to note that a lot of debt settlement companies advertise themselves as debt consolidation companies, but settlement and consolidation are not the same thing. For more information, check out WalletHub’s Debt Settlement Guide.
- Bankruptcy: Bankruptcy is the most serious, costly, and credit-damaging debt solution. It will provide you with debt relief, as certain bills may be discharged. But you’ll also have to hire a lawyer, and a negative mark will remain on your credit reports for 7 to 10 years. Bankruptcy should only be a last resort. For more information, check out WalletHub’s Bankruptcy Guide.
Debt consolidation is far from your only option if you’re struggling to make ends meet. And it’s important to consider ALL of your options carefully before deciding how to proceed because when you’re having debt problems, there is no perfect remedy. Each option will have some downsides, so you need to focus on minimizing risk, maximizing return, and staying disciplined until the job is done.
Debt Consolidation Tips & Strategies
By now, you know how debt consolidation works and the various approaches that one can take toward it. Regardless of which option you choose to pursue, there are a number of steps that you can take to ensure that your efforts are not in vain and your situation will improve.
- Maximize Your Credit Standing: Whether you use a personal loan, a balance transfer credit card, or home equity to consolidate debt, having the best possible credit standing will make the road to recovery smoother and less expensive. Your credit standing signals to lenders how financially trustworthy you are and plays a big part in whether you get approved and what rates you pay. You can read more about maximizing your credit in WalletHub’s Credit Improvement Guide.
- Use a Debt Calculator: In order to determine if debt consolidation is possible, let alone beneficial, you must figure out how much your monthly payment will be, how long your total debt will take to pay off, and how much you’ll wind up paying in finance charges. A debt calculator can help you determine those things, as well as tell you whether or not you can save money with a different credit card or loan offer.
- Make a Budget: Debt consolidation will prove meaningless if you don’t develop good spending habits as well. You can’t solve old problems if new ones are constantly cropping up, after all. So, make a list of your expenses (including debt payments) in order of importance and cut out anything that would cause your spending to exceed the money you make.
- Stay Disciplined: Once you settle on a plan for getting out of debt, stick to it. Avoid temptation and focus on how much easier things will be once the weight of debt is lifted off your shoulders. One of the biggest temptations will be the various credit card and loan offers that come your way once your situation improves. Once you have more disposable income, lenders may send you a lot of deals. Taking them up on one isn’t necessarily bad, but you have to make sure not to relapse.
- Build an Emergency Fund: A rainy-day fund makes it so much easier to withstand a bad economy or unexpected expenses. Your goal should be to save up about a year’s worth of take-home in such an account. As long as you’re confident in your ability to make minimum payments on what you owe, starting your emergency fund should actually take precedence over really focusing on getting out of debt. Otherwise, you’re still going to be one major unexpected expense away from winding up back at square one.
- Use the Island Approach: The Island Approach is a method that involves using separate accounts for different types of credit card transactions. By carrying your revolving balances on one credit card and using another card for normal, everyday expenses that you pay in full, you’ll reduce the amount of interest you pay. You’ll also get a better understanding of your spending and payment habits. For example, if you ever find interest charges on your everyday credit card account, then you’ll know you’re spending beyond your means and need to cut back.