What is debt consolidation? | The bank rate

Even if you work hard to manage your money the right way, paying off high-interest debt monthly can keep you from reaching your financial goals. No matter how much you owe, it can take months or even years to get out of it.

One way to manage multiple debt payments is to consolidate. Debt consolidation is a form of money management where you pay off existing debts by taking out a new loan, usually through a debt consolidation loan, balance transfer credit card, a student loan refinance, home equity loan or HELOC.

What is debt consolidation?

Debt consolidation consists of merging several debts into one. Instead of making separate payments to multiple credit card issuers or lenders each month, you consolidate them into one payment from a single lender, ideally at a lower interest rate.

You can use debt consolidation to merge several types of debt, including:

  • Car loans
  • Credit card
  • Medical debt
  • Payday loans
  • Personal loans
  • Student loans

Although debt consolidation does not wipe out your balance, the strategy can make paying off debt easier and less expensive. If you get a low interest rate, you could save hundreds or even thousands of dollars in interest. Managing one payment can also make it easier to control your bills and avoid late payments, which can hurt your credit.

Types of debt consolidation

No matter what type of debt you are consolidating, if you are looking for how to consolidate your debts, you have several options to choose from.

debt consolidation loan

Debt consolidation loans are personal loans that consolidate multiple loans into one fixed monthly payment. Debt consolidation loans typically have terms between one and 10 years, and many will allow you to consolidate up to $50,000.

Most lenders do not specify how loan proceeds can be used. It is therefore up to the borrower to apply the proceeds of the loan to the outstanding credit card and loan balances they wish to consolidate. You will also start making monthly payments to the new lender for the duration of the loan.

Ideally, you want to focus on the debts with the highest interest rates first. Also, this option only makes sense if the interest rate on your new loan is lower than the interest rates on your credit card or previous loan products. Although you may get a more affordable monthly payment if the lender extends the term of the loan, you will still pay significantly more interest by consolidating.

Best for: Borrowers who want a simpler repayment process.

Balance transfer credit card

If you have multiple credit card debts, a balance transfer credit card can help pay off your debt and lower your interest rate. Like a debt consolidation loan, a balance transfer credit card transfers multiple streams of high-interest credit card debt to a single credit card with a lower interest rate.

Most balance transfer credit cards offer a 0% APR introductory period, which typically lasts 12 to 21 months. If you manage to pay off all or most of your debt during the introductory period, you could potentially save thousands of dollars in interest payments.

However, if you have a large outstanding balance after the period ends, you could find yourself more in debt, as balance transfer credit cards tend to have higher interest rates than other forms of debt consolidation. debts.

Best for: Borrowers who can afford to pay off their credit cards quickly.

Student Loan Refinance

If you have high-interest student loan debt, refinancing your student loans could help you get a lower interest rate. Student loan refinancing allows borrowers to consolidate federal and private student loans into one fixed monthly payment and on better terms.

Although refinancing can be a great way to consolidate your student loans, you will still need to meet the eligibility criteria. Additionally, if you refinance federal student loans, you will lose federal protections and benefits, such as income-contingent repayment and deferment options.

Best for: Borrowers with high interest private student loans.

Home Equity Loan

A home equity loan, often referred to as a second mortgage, allows you to tap into the equity in your home. Most home equity loans have repayment periods of between five and 30 years, and you can usually borrow up to 85% of the value of your home, less any outstanding mortgage balance.

Home equity loans tend to have lower interest rates than credit cards and personal loans because they are secured by your home. The downside is that your home is at risk of foreclosure if you fail to repay the loan.

Best for: Borrowers with a lot of equity in their home and a stable income.

Home equity line of credit

A home equity line of credit (HELOC) is a home equity loan that acts as a revolving line of credit. Like a credit card, a HELOC allows you to withdraw funds as needed with a variable interest rate. A HELOC also taps into the equity in your home, so the amount you can borrow depends on the equity in your home.

A HELOC is a long-term loan, with an average drawdown period – the period during which you can withdraw funds – lasting 10 years. The repayment term can be up to 20 years, during which time you can no longer borrow from your line of credit.

Best for: Borrowers with high equity in their property and wanting a long repayment term.

How to consolidate your debt

If you’re trying to figure out how to consolidate your debt, the process is pretty similar regardless of what form of debt consolidation you use. It is important to understand that debt consolidation is different from debt settlement. With debt consolidation, you will use the funds from your new debt consolidation loan to pay off all your existing debts in full.

Once you have obtained the funds for your personal loan, home equity line of credit or other debt

consolidation loan, you can start the debt consolidation process. Use these funds to pay off all your existing debts. You will then only have one monthly loan payment, usually with an interest rate lower than all the interest rates of your previous loans.

Advantages and disadvantages of debt consolidation

Debt consolidation is not the right choice for everyone; before consolidating your debt, consider the pros and cons.


  • Improved credit rating. You might see an increase in your credit score if you consolidate your debt. Paying off credit cards with debt consolidation could lower your credit utilization rate, and your payment history could improve if a debt consolidation loan helps you make more on-time payments.
  • Less total interest. If you can consolidate multiple debts with double-digit interest rates into one loan with an interest rate below 10%, you could save hundreds of dollars on your loan.
  • Easier debt repayment process. It can be difficult to keep track of multiple credit card or loan payments each month, especially if they are due on different dates. Taking out a debt consolidation loan makes it easier to plan your month and control payments.

The inconvenients

  • Collateral at risk. If you use any type of secured loan to secure your debt, such as a home equity loan or a HELOC, that collateral can be seized in the event of a late payment.
  • Possible higher cost of debt. Your savings potential with a debt consolidation loan largely depends on the structure of your loan. If you have a similar interest rate but choose a longer repayment term, for example, you’ll end up paying more interest over time.
  • Initial costs. Any form of debt consolidation may incur fees, including origination fees, balance transfer fees, or closing costs. You’ll want to weigh these fees against the potential savings before applying.

How to decide if debt consolidation is right for you

Debt consolidation makes more sense if your expenses are under control and your credit score is high enough to qualify for a more competitive interest rate than what you are currently paying. You should also consider your current debt load when deciding if debt consolidation is right for you. If it’s manageable, doesn’t take up an excessive amount of your gross monthly income, and will take more than a few months to pay off, consolidating your debt could be a smart financial decision.

When not to consolidate your debts

Debt consolidation is only effective if you are disciplined enough to stop using the credit cards you are paying off. Otherwise, you risk accumulating much more debt than you started with. It is equally important to make sure that you can afford the monthly payment amount on the debt consolidation loan. If the payment stretches your budget too much, you could fall behind quite quickly and hurt your credit rating.

Also consider your credit rating before deciding to consolidate your debts. If your credit score is at rock bottom, the lender or creditor will likely only offer higher interest rates to help you consolidate what you owe.

At the end of the line

If you’re interested in debt consolidation, make sure you’ve looked at the underlying reasons for how you got into debt in the first place. If you’re in a more stable place but got into debt earlier in your life, debt consolidation can make a lot of sense. Take the time to consider all of your options and get quotes from several lenders, including credit unions, online banks, and other lenders. Compare interest rates, fees and terms before finalizing your decision.

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