What is debt consolidation? Is it worth it?

Debt Consolidation

Debt consolidation rolls all of your loans into a single, more manageable plan — but it’s not a silver bullet. Here’s what you need to know to see if consolidating your debts is a viable option.

We’ve all been there: The credit card bills are piling up until payday, when you’ll have some money in your account. But by the time payday finally rolls around, they’re piled so high that by the time you’ve paid them all, you’re already almost completely out of money until the next payday. This leaves you with some tough choices.

Do you…

  • Pay a chunk of each bill and put everything else you need to buy for the next two weeks on your credit cards?
  • Skip paying a couple of the bills and hope that if you only miss the deadline by a week or two, the lender won’t notice? 
  • Pay only the minimum on all of them, figuring you’ll catch up next time? 
  • Delete the bills and reminders from your inbox and pretend you never saw them?
  • Take out a payday loan and gamble that you’ll be OK once the next paycheck arrives?

None of these options are good, and a few of them will leave you in a situation that’s even worse than what you’re facing now, but with some lasting damage to your credit score. 

If you’ve ever grappled with this, it might be time to consider a debt consolidation loan. 

It’s possible to consolidate many different forms of debt, but it’s important to first figure out what’s best for your particular situation. For those struggling with credit card debt, payday loans, student loans or other personal debts, here’s a complete overview to help you make an informed decision about whether debt consolidation is the right choice for you.

What is debt consolidation?

Debt consolidation rolls all outstanding debts into a single monthly payment, usually with a lower interest rate. Because this involves combining multiple debts into a single loan, this is referred to as “consolidating” your debt.

Basically, borrowers take on a new, larger loan and use that money to pay off other existing loans that have higher interest rates. Debt consolidation could be a good option if borrowers have a lot of high-interest debts they need to pay off and are given favorable terms with a lower interest rate than their current debts.

The main goal of debt consolidation is to pay off high-interest debts first, like credit cards and payday loans. However, a lower interest rate isn’t always guaranteed and will depend on the borrower’s credit score, income, and other factors.

This is why debt consolidation isn’t always the best choice for everybody. Interest rates will vary, and borrowers with poor credit scores may be rejected, or receive worse terms than their existing debts.

All sorts of debts can be consolidated, including credit card debt, medical debt, student loan debt, payday loans, auto loans, and other personal debts.

It’s important to remember that debt consolidation will never wipe out your balance – you’re stuck with that unless you are able to negotiate forgiveness with your lenders. However, if you are able to get a lower interest rate on your new loan, you will usually save a boatload of money.

The pros and cons of consolidating your debts

Before jumping to a conclusion and applying for loans, it’s important to consider the potential benefits and drawbacks of debt consolidation.


  1. Better budgeting, simpler to keep track of: Debt consolidation can help simplify debt payments. Instead of having to juggle several different debts, each with different repayment structures and interest rates, borrowers will now only have one payment each month to remember. If you’ve been missing a couple of payment deadlines a month, this will save you quite a bit in late fees, and help your credit report from taking a hit.
  1. Lower interest rates allow you to pay off principal faster: Debt consolidation loans usually have lower interest rates and more favorable terms than other existing debts that borrowers might have. That means less money used to pay interest, and more money used to pay off the principal.
  1. You can improve your credit score: When borrowers apply, there will be a small hit to their credit scores because lenders will need to do a hard credit check. However, paying off existing debts, and making consistent payments towards your new debt consolidation loan can improve your credit score over the time of the loan.


  1. Requires a high credit score: Borrowers will usually get rejected if they do not have a high enough credit score. This is one of the most challenging aspects of this type of loan, because borrowers with burdensome high-interest debt are usually only in that situation because their poor credit scores have given them no other option.
  1. Borrowers could end up paying more interest over time: Debt consolidation loans have repayment plans of around three to five years. While borrowers may be given lower interest rates, they may end up paying off their debt consolidation loan for far longer than they would have needed to pay off their other debts. This can result in them paying more interest over time than they would have paid with their high-interest debts. If you can afford it, put some extra money toward your loan principal each month. Even paying an extra $10-$20 a month can lead to significant savings over five years.
  1. The loans can pull borrowers further into debt: This is the biggest risk with debt consolidation loans, and the reason they can be so dangerous to some people. Debt consolidation is not an excuse to spend more money. If borrowers don’t fix their underlying spending problems that brought them to this position in the first place, debt consolidation can encourage more spending and quickly snowball their cycle of debt. 
  1. Assets could be at risk: Some, not all, personal loans could require borrowers to put up collateral (like their house) to guarantee their debt consolidation loan offers. If the debt isn’t paid back, even if it’s due to an unexpected event, borrowers could end up losing the property they put up.

How does a debt consolidation loan work?

Debt consolidation works like this:

  1. Search for the lowest interest loan you can find, with favorable repayment terms.
  2. Use the new low-interest loan to pay off all of your high-interest loans.
  3. Pay back the low-interest loan.

When borrowers apply for a debt consolidation loan, lenders will look at credit score, credit history, income, and other financial details to determine interest rates, payment terms, and lending amounts.

Once approved, the lender will use the money to pay off the agreed-upon debts. In some cases, lenders will deposit money directly into the borrower’s bank account and they will be responsible for paying off the debts themselves with the funds received.

It’s also possible to consolidate debt through a balance transfer credit card, or by getting a second mortgage.

When is the best time to consolidate your debts?

Debt consolidation becomes a good option when borrowers find themselves with several high-interest loans to pay off — but only if their credit scores haven’t been severely impacted by these loans already. Loans aren’t typically approved for people with poor credit scores, and if they are, they’re usually offered unfavorable terms and high interest rates.

Debt consolidation loans might not be a good idea if borrowers plan to pay off their high interest and continue piling on debt. Paying off a credit card with a debt consolidation loan, and then maxing it out again will only pull them further into debt.

Top debt consolidation methods

There are several different ways to consolidate debt. They include:

Personal loans

The most common type of debt consolidation loan is a personal loan issued by a financial institution, credit union, or online lender. These personal loans will come with a fixed repayment timeline (typically anywhere from six months to five years), set interest rate (determined at the time of application), and usually are unsecured, meaning borrowers don’t have to put up any collateral. Personal loans also have higher borrowing limits than other methods, with some lenders providing loans of $50,000 or more.

Balance transfer credit cards

A balance transfer credit card often comes with an introductory offer of an interest rate as low as 0% for a predetermined promotional period. Borrowers can take advantage of this by transferring all of their other credit card debts onto the new card. They may have to pay some balance transfer fees, but like any other debt consolidation, they now have one single card to pay off, with a much lower interest rate.

While this might seem like a good option at first glance, it should only be considered for smaller debts that can be paid off quickly. Once the promotional period is over (usually no longer than 18 months), the interest rates could quickly shoot up to around 20%, the equivalent of your other previous credit cards. 

Home equity loans

Also known as taking out a second mortgage, a home equity loan allows homeowners to use their property as collateral to secure a low-interest loan. The loans have fixed interest rates that are usually lower than unsecured personal loans, but if borrowers are unable to repay the loan, they could lose their homes. Another option would be opening a home equity line of credit, or HELOC. This is a revolving line of credit — similar to a credit card. If you’re 62 or older, you have another option — a reverse mortgage. It allows you to convert part of the equity in your home into cash without having to sell your home or pay additional monthly bills. The Federal Trade Commission (FTC) has a handy guide explaining the pros and cons of taking out a reverse mortgage.

401(k) loans

Many 401(k) plans allow their users to borrow money against their savings balance. Users can borrow up to half of their retirement account balance, and the payment period lasts for a maximum of five years. They’re cheaper than balance-transfer credit cards and offer a higher borrowing limit of $50,000. However, it comes with the risk of significantly slashing your retirement account savings, tax consequences, and penalties. But the biggest risk of a 401K loan is that it hinges on your employment. Many employers require you to pay the loans back in full if you’re fired, laid off or leave the company for another job. Be sure to research your company’s rules and repayment terms so you don’t get hit with a surprise lump repayment you can’t afford.

The true cost of using a 401(k) loan is that borrowers not only risk their savings, they also miss out on market gains and compound interest they would have accrued from leaving their 401(k) plan alone.

Debt consolidation loan

A debt consolidation loan is the most obvious choice. It’s a loan designed specifically for the predicament that you are in. Typically, you will need a credit score in the 600s to qualify, and loan amounts can be as high as $50,000. Interest rates for consolidation loans usually start around 6%. Only use a debt consolidation loan if the interest rate you qualify for is lower than the interest rates of your current loans. Use an online calculator to see if how much money you’d save.

Credit card balance-transfer offer

Many credit cards offer an introductory balance transfer period, where you pay 0% interest for a few months. You can only transfer other credit card balances onto the card, so this may not help with other forms of debt. These introductory periods can last anywhere from 6-18 months.

Be sure to check your mail for these kinds of offers. Credit card companies are required by law to approve the majority of offers they make through the mail. So if you get an offer with an enticing balance transfer offer, you’re likely to get approved.

Zero percent APR balance transfer cards are ideal for those who can pay off their debt within the introductory period. Because once that intro period is up, you’ll be paying the full APR of the credit card. So be sure that either a) you can pay off the debt within the 0% APR balance transfer period or b) the post-teaser balance transfer rate is lower than the interest rate you’re currently paying.

Home equity line of credit (HELOC)

A Home Equity Line of Credit, or HELOC, is a loan that is secured by your home. You can draw your loan whenever you need it, and the amount you can draw is based on the equity you have in your home. Currently, HELOC annual percentage interest rates are in the 3.5% range, making them one of the cheapest ways to consolidate your loans. Additionally, the loan terms are extremely long — 10 to 20 years — giving you plenty of time to repay your debt.

Of course, this is only an option if you own a home and have equity in it. Additionally, you are putting your home up as collateral, so you could potentially lose your home if you fail to repay the loan.

What about debt consolidation programs/debt settlement companies?

If you’ve been researching debt consolidation, you’ve likely come across companies that offer debt consolidation as a service. And they might sound enticing.

You must approach these cautiously.

These companies essentially take over the payments to your lenders, then require you to make payments to a separate bank account in your name. These companies typically rely on the ability to negotiate with your lenders to have your debts reduced, then take fees and a percentage of the money saved.

It’s a business that works in theory, but in practice can be shady. Additionally, because some will stop paying your bills as a negotiating tactic, you risk hurting your credit score, so use these as a last resort.

If you choose to go this route, be sure the firm is licensed with the state and is in good standing with the Better Business Bureau.

When is debt consolidation a good idea?

For some, consolidating debts can be life-changing, while for others it simply isn’t practical. Here are some general guidelines to help determine if it’s a good idea for you.

Debt consolidation is a good idea if:

  • You are overwhelmed by multiple monthly bills and can’t reliably pay them off
  • You have taken inventory of all your existing debt
  • Your total debt isn’t more than 40% of your gross income
  • Your credit score is high enough to secure a low to 0% interest debt consolidation loan
  • You have done all your research and understand what you’re getting into

Debt consolidation is not a good idea if:

  • Your credit rating is too low for you to secure a low-interest loan
  • You are consolidating unsecured loans with a secured loan
  • You are spending more than you earn or if you still haven’t solved your spending problems
  • Your debt load is too small; in that case, applying for debt consolidation often doesn’t make sense

Still not sure about debt consolidation? This video may give you a better idea.

Debt consolidation by state