People struggling with heavy debt are often told to consolidate their debt. But it’s important to understand that consolidating your debt isn’t the same thing as paying off your debt. And debt consolidation isn’t the same as credit counseling or debt negotiation, either.

Simply put, consolidating debt merely means to combine all your debts into one.

As a tool for debt management, debt consolidation could help you reduce the interest you are being charged on your debt and/or make it simpler to pay down your debt. But there are many different ways to consolidate debt. Deciding which one is right for you depends on your goals and your budget.

Options for consolidating your debts:

1. Borrow money to pay them all off. With this method, you consolidate multiple debts into one new debt (a loan). As to where you could get the loan, here are some options:

  • Personal lenders. You could apply with a personal lender to get a loan that has lower interest than your debts. You’ll still have debt (the loan), but it could be at a lower interest rate. And instead of having many bills to pay each month, you’ll just have the one loan payment.
  • Your 401(k). Some plans allow you to borrow from the balance as long as you repay the account within five years. But this should be a last resort since your 401(k) is meant for your retirement years. Also, if you leave the job associated with the account, the loan will be due immediately.
  • Family or friends. They would probably agree to a lower interest rate than a bank would, but asking for money from people in your personal life is risky. It could create difficult expectations or resentment. At worst, it could involve a previously good friend or family member taking legal action on you if you’re unable to pay them back.
  • Your house. If you own a home and have enough equity, you may be able to take out a home equity loan or line of credit and use the money to pay off debts. Or, you can refinance your home and take cash out at closing for your debts. You’ll move high interest debt to a lower rate mortgage, and the interest is tax-deductible. However, using your house to pay off debt can be very risky. If you can’t make the payments, you put yourself at risk of foreclosure.

2. Use a balance-transfer credit card offer. A transfer of a credit card balance to a card offering a lower interest rate can be helpful, but BE CAREFUL. Make sure to:

  • Read the fine print to calculate the balance-transfer fee
  • Choose a card without an annual fee
  • Be absolutely confident that you can pay off the balance before the rate expires
  • Once you make the transfer, put away old and new cards and stop charging

3. Work with a credit counseling service. These services ask you to make one monthly payment, which then is used to pay creditors. You’ll pay back 100 percent of the debt, plus interest. This method lets you just focus on one interest rate and one payment per month, so it’s helpful if you are struggling with lots of accounts with high interest rates. However, fees can be high. Many services have poor reputations and while using one you may need to sacrifice the ability to open and use additional credit lines and, in some cases, your credit score could be hurt.

In general, if you are unable to make minimum payments on your debt, debt consolidation may not be the best option for you. Better options could include debt negotiation (AKA debt settlement) or credit counseling. To learn more about those options, please visit the Debt Strategies section of our website.