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In a nutshell
Debt consolidation can help you streamline and lower your monthly debt payments, lower your interest rates or both. However, you'll want to make sure it's the right choice for you.
- While there are many advantages to debt consolidation, downsides include fees and potentially putting your assets on the line.
- Common ways to consolidate debt are debt consolidation with a personal loan, debt consolidation with a home equity loan or a balance transfer credit card.
What is debt consolidation?
If you're juggling card card balances, personal loans, student loan debt, and medical bills, keeping track of your different debt loads and payment plans can feel like a full-time job. Currently, the average credit card debt for U.S. householders is $6,501, according to Experian.
Holding student loans, a car loan, personal loans and credit card balances all at the same time can be a lot to keep track of. If you're shouldering a heavy load of high-interest debt, by bringing together your different debts into a single loan you can streamline your finances. What's more, you can often lower your monthly payment, reduce your interest rate or potentially both.
How to consolidate your debt
To consolidate your debt, you'll need to apply for a consolidation loan with a bank, credit union or online lending platform. If you're consolidating your debt through a credit card balance transfer, which we'll get to in just a bit, you'll need to apply with the credit card issuer.
Once they issue the consolidation loan, you can use it to pay off all (or some) of your other debts. Then you’ll pay back the consolidation loan with regular monthly payments.
How does debt consolidation loan work?
Debt consolidation is when you lump together your existing debt into a single, new loan. It works like this: You take out a new loan to pay off your old debts, and the remaining balances on your loans and credit cards are streamlined into a single payment. Then, you continue making payments until your loan is paid off. When you apply for a debt consolidation loan, you are given what's essentially a new loan. This means a new payment plan, interest, and fees.
When you apply to consolidate your debt, the lender will do a hard pull of your credit, which can negatively impact your credit score. Once your application is accepted, and you've reviewed the rates, terms and conditions, you'll receive your new loan, use it to pay off your old debts, and then repay the new loan in monthly payments.
Learn more:
- How to check your credit score
- How to fix your credit score in 10 easy steps
Besides simplifying your finances, debt consolidation can lower your payments. However, this can stretch out your loan, which in turn can mean paying more in interest and fees overall. Through debt consolidation, you might also be able to negotiate for a lower interest rate, and in some cases you might be able to lower your monthly payment and interest rate.
Types of consolidation loans
There are three main types of consolidation loans.
Debt consolidation with a personal loan
Debt consolidation with a personal loan is the method discussed above. You apply for a new personal loan, then roll together your existing loans into the new loan. Common types of debt you can consolidate in this way are high-interest personal loans, credit cards, student loan debt and medical debt.
The major advantage of this approach is that you might be able to lock in a lower monthly payment, lower interest rate or both with your new loan. Online lenders such as SoFi, Upgrade and Happy Money can offer loan amounts of $1,000 to $50,000, and in some cases up to $100,000. APRs range between 8% to 36%. That’s probably a lower rate than your credit card, and might be lower than your other debts.
| Lender | APR | Min. credit score | Loan amount |
|---|---|---|---|
SoFi | 8.99% to 25.81% (includes 0.25% autopay discount) | 680 | $5,000 to $100,000 |
Upgrade | 8.49% to 35.99% | 580 | $1,000 to $50,000 |
Happy Money | 11.72%to 17.99% | 640 | $5,000 to $40,000 |
Debt consolidation with a personal loan works in the same fashion as any other installment loan. Your loan comes with a set interest rate for a period of time. You're responsible for making monthly payments on your new loan until it's paid off.
The amount, interest rate and terms you qualify for depends on several financial and credit factors: your credit score, income and debt-to-income (DTI) ratio. The higher your credit score and the lower your DTI ratio, the better your terms and rates. It also can vary based on the loan term. Shorter terms typically have lower interest rates, as they pose less of a risk to lenders.
Debt consolidation with a home equity loan
Consolidating your debt with a home equity loan is similar to consolidating it with a personal loan. You take your existing debt and lump it together into a new loan. The major difference is that you're using the equity in your home to take out the loan, so home serves as collateral. Should you have trouble keeping up with payments, the lender can seize your home and sell it to recoup their losses.
You typically need to have built 15% to 20% equity in your home for this type of loan. In other words, the amount you owe on your mortgage against the appraised value of your home can't be more than 80% to 85%. This is also known as the loan-to-value (LTV) ratio.
The advantage of consolidating in this way is that interest rate on home equity loans is often lower than with personal loans. On the other hand, you run the risk of your house being seized if you can’t make payments on the loan.
Credit card balance transfer
Another way to consolidate your debt is by way of a credit card balance transfer. With a credit card balance transfer, you take your remaining balances from existing credit cards and put them on a new one. The key here is to transfer to a card where you've been approved for a lower interest rate, which helps you save on interest.
Some cards feature a zero-percent APR introductory period, where you owe zero interest for a short period of time. Others let you transfer the balances from debt other than credit card debt. For instance, you might be able to transfer your car loans, personal loans or student loans. If you're able to get a zero-percent introductory offer on your transfer credit card, you'll want to pay off your balance before the period ends, and the standard interest rate kicks in. Otherwise, you might end up paying more in interest in the long term.
Pros:
- Simplified payments: By clustering your different debts that are spread out among different creditors and lenders into a single lender, you only need to make a single payment. That means having fewer due dates and payment amounts to keep track of and ultimately less hassle.
- Can save you money: If you can secure a lower interest rate when consolidating debt, that means you'll pay less interest on your debt.
- Can lower your payments: Lowering your monthly payments means freeing up more money each month. That's "additional cash" that you could use for another financial goal, such as saving for an emergency fund, saving for your kid's college education or toward retirement.
Cons:
- Fees may be involved: Personal loans might have origination fees, which are due when you take out the loan. They're usually 1% to 5% of the loan amount or a flat fee. Balance transfer credit cards usually come with fees between 3% to 5% of the loan amount.
- You might not qualify for a better loan with lower rates: Depending on your credit and financial situation, you might not be able to consolidate your debt with a lower interest. In that case, it might not be worth your while to apply for debt consolidation if it won't net you much — if any — savings.
- Can put your assets on the line: If you're consolidating debt with a secured personal loan or home equity loan, a major downside is that you could risk losing your home or some other valuable asset. Fall behind on your payments and the lender can take your assets to get their money back.
Is debt consolidation a good idea?
Debt consolidation could be a good route if you'd like a way to knock out your debt in a more streamlined, simplified manner.
It could also be worthwhile if you have a fair amount of debt to pay off, and it could either free up money each month, save you money on what you're paying in interest or both. If you have excellent credit and can snag a lower interest rate, then the interest saved can offset any fees owed.
When debt consolidation isn't worth it
Debt consolidation might not be worth it if you are nearly at the finish line with paying off your debt. That's because the money saved won't offset the origination or balance transfer fees. It might not also be the best route for you if your credit and finances are in a sound place. If you aren't able to secure a lower interest rate than the average of your existing debt, then it won't make financial sense.
The AP Buyline roundup
Gauging whether debt consolidation is a solid option for you depends on a handful of personal factors such as your existing debt load, credit score and the intended goals for consolidating your debt.
Figuring out how much you can potentially save in interest fees or the amount of money you free up each month can help lead you to the best choice. It could help simplify your debt payments, but you'll also be on the hook for paying any upfront loan costs.
Frequently asked questions (FAQs)
Is it a good idea to consolidate credit cards?
It can be a good idea to consolidate your credit cards if you can secure a balance transfer card with a lower interest rate. The lower the interest rate, the better. If you can move the balances from your cards to one with a featured zero-interest introductory fee, you could save a significant chunk in interest fees if you pay off your balance before the introductory rate ends and the standard rate kicks in.
Does consolidation hurt your credit?
Debt consolidation can negatively impact your credit score temporarily. When you apply for debt consolidation, the lender will do a hard pull of your credit. This typically results in a slight decrease in your score, usually by a few points. Your score should go back up within a few months. And just like any type of loan, if you fall behind on payments, you also risk lowering your score.
What are the disadvantages of a debt consolidation loan?
The potential downsides of a debt consolidation loan include potential origination or balance transfer fees. Moreover, you might not qualify for a loan with lower interest rates or more favorable terms, and you might be required to put your home or other assets at risk.
AP Buyline’s content is created independently of The Associated Press newsroom. Our evaluations and opinions are not influenced by our advertising relationships, but we might earn commissions from our partners’ links in this content. Learn more about our policies and terms here.
