Are you feeling overwhelmed by multiple debt payments each month and wondering if you’re overpaying? Enter — debt consolidation.
By consolidating multiple debts into a single new loan or credit card, many borrowers can streamline their payments and reduce their borrowing costs.
But is the move right for you? Here’s a look at the ins and outs of debt consolidation and when it can be a good idea.
What does debt consolidation mean?
Debt consolidation refers to combining multiple debts into a single, larger debt. It involves using a debt consolidation loan or credit line to pay off two or more smaller debts. For example, getting a $10,000 personal loan and using it to pay off $5,000 in credit card debt and $5,000 in medical bills is considered debt consolidation.
Consolidating debt can be beneficial if you can get a lower interest rate than what you have on your existing accounts. For example, say you have $5,000 of credit card debt across three credit card accounts that have an average annual percentage rate (APR) of 25%.
With monthly payments of $250, it will take you 26 months to pay off the balance, and you’ll pay $1,380 in interest. On the other hand, if you get a debt consolidation loan with a 15% APR and make the same $250 monthly payments, you could pay off the $5,000 balance in 23 months and would pay just $713 in interest.
Consolidating debt can also streamline your repayment process, as multiple payments each month can be stressful, time-consuming, and lead to multiple late fees if you miss payments.
Further, revolving credit accounts only require minimum payments each month that can leave you in an endless cycle of paying mostly interest. If you opt for an installment loan and use it to pay off multiple debts, you’ll have a single monthly payment and a clear path to paying off the debt in full.
Types of debt consolidation loans
You can consolidate debt in a few different ways, including through balance transfer credit cards, personal loans, or home-equity-backed loan products.
Balance transfer credit cards
A balance transfer credit card allows you to move an outstanding balance from an existing credit card over to the balance transfer card, often for a fee of 3% to 5% of the transfer amount.
But when are balance transfer cards good for debt consolidation? They can be helpful if you have outstanding balances on multiple credit cards and can get approved for a new card with an interest rate that’s lower than the rates on your existing cards.
No-interest introductory periods may also be a good idea. However, be mindful of the promotional term and the normal APR after the promotion ends. If you can’t pay off your debt balance during the introductory period, you’ll be charged interest on the outstanding balance at the card’s standard rate.
For example, say you have a $2,000 credit card balance with a 29.99% APR and are making $140 monthly payments — you would pay off the balance in 18 months and pay $436 in interest.
If you get a balance transfer card with an 18-month 0% APR promotion and 5% balance transfer fee, you could make the same $140 monthly payment, but pay the new balance off ($2,100) in 15 months, and save $336.
Personal loans
Personal loans, sometimes referred to as debt consolidation loans, are lump sum installment loans that you repay through monthly payments over a set term, such as five years, plus interest and fees. Many financial institutions offer them, including banks, credit unions, and online lenders.
Available loan amounts often range from $1,000 to over $100,000 and terms typically range from two to seven years. Plus, lenders can send loan funds to your creditors directly, and may even discount your rate for it.
Personal loans can be a good option if your credit is in decent shape. They’re usually unsecured, so approval will depend heavily on your credit profile. Shop for loans online and get prequalified with multiple lenders to see what APR and terms you might qualify for.
Once you prequalify, compare loan amounts, APRs, fees, loan term lengths, monthly payment amounts, overall costs, funding times, and customer satisfaction ratings between lenders. For example, if time is of the essence, choose lenders with quick funding times.
Note that prequalification is not an offer of credit, but gives the lender (and you) an idea of what you might qualify for based on your credit profile. You’ll need to formally apply once you decide which lender to go with. The lender will conduct a hard credit inquiry when you apply which could temporarily ding your score.
All APRs reflect autopay and loyalty discounts where available | LightStream disclosure | SoFi Disclosures | Read more about Rates and Terms
Important: Prequalification does not hurt your credit score, but applying for a loan can lower your score temporarily by a few points.
Home equity loan products
Home equity loan products — including home equity loans, home equity lines of credit (HELOCs), and cash-out refinance loans — are an option worth considering for homeowners who are looking into debt consolidation.
If you go this route, you’ll borrow against a portion of the equity you’ve built in your home. The way the loan works depends on the product you choose:
- Home equity loan: A lump sum payment that you repay, plus interest, over a set term, such as 15 or 30 years. These have closing costs and take a second lien position on your property.
- HELOC: A credit line that you use on an as-needed basis for a set amount of time called the draw period — often 10 years. After the draw period, the balance becomes due. You can usually pay it off in a balloon payment or convert it into a term loan that you pay off over 20 years. HELOCs may come with fees and take a second lien position on your property.
- Cash-out refinance: A new, larger mortgage that replaces your existing one and allows you to cash out the funds left over after paying off your mortgage balance. These have closing costs and take the first lien position on your home. A cash-out refinance is usually only a good idea if you can refinance to a lower interest rate than what you currently have on your mortgage.
Using your home as collateral may help you secure a larger loan amount than you can get with other loan options and get lower interest rates. On the downside, it puts your home on the line if you can’t make your payments and can come with hefty fees.
How does debt consolidation work?
If you want to consolidate your debt, start by taking inventory of your current debt situation. Make a list of all of your debts and note the following for each:
- Balance amount
- Payment amount
- Interest rate
- Payoff date (when applicable)
- Overall payoff cost
From there, consider your various debt consolidation options, from credit cards and personal loans to home equity loans. Assess which are available to and best for you, and shop around to get quotes.
Then, compare options to see which offers the best value. Once you have a winner, run the numbers against your current debts to make sure consolidating will help you save.
Learn More: How Does Debt Consolidation Work?
How do I get a debt consolidation loan?
If you want to move forward with a debt consolidation loan, you’ll need to apply with your lender of choice. The lender will typically run a hard credit check and verify your identity, address, and income.
If you opt for a home equity loan, you’ll have to undergo a few additional steps so the lender can assess the value of your property, verify that it’s insured, and make sure you’re up to date on property tax payments.
Upon approval, the lender will make the funds available to you or, in some cases, send them to your creditors directly. At that point, you can pay off the debts you’d like to consolidate.
Depending on the rates and terms of your debts and the amount of your debt consolidation loan, you may not want or be able to consolidate all of your debts.
For example, if you have a loan with an APR that’s lower than your new loan’s APR, you may want to leave it as-is. Or, if you can’t get a loan large enough to cover all of your debts, you may need to prioritize those with the highest interest rates.
Once you pay off all debts you’d like to consolidate, you’ll need to make your new loan payments on time (and avoid acquiring more debt).
Learn More: How Do I Get a Debt Consolidation Loan?
Is debt consolidation a good idea?
Debt consolidation has its risks and benefits. It can be a good idea if it helps you pay off debt faster or lowers your payment. However, it won’t be so good if it ends up increasing your costs and debt amount. If you’re on the fence, ask yourself the following questions:
- Can you qualify for a loan or credit card that will allow you to consolidate some or all of your debt and save money?
- Would you prefer one monthly payment and a repayment plan with an end date?
- Can you afford to make the monthly payment required for a number of years?
If you answered yes to the above three questions, debt consolidation could be a good option for you. It can be a helpful tool if you’re ready to draw a line in the sand and get serious about paying off your debt. However, if you answered no to any of the questions, you may want to hold off on debt consolidation for now.
Learn More: Should You Pay Off Debt or Save?
Debt consolidation loans for bad credit
If you currently have bad credit, it can be difficult to get approved for a loan or credit card at a competitive rate. However, some reputable lenders specialize in helping credit-challenged borrowers.
Further, you’ll have a better chance with secured loans like those backed by home equity. Due to the collateral, lenders face less risk and can offer more lenient eligibility requirements. Another possibility is to get a loan with the help of a cosigner who promises to pay your loan off if you can’t.
FAQ
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