Debt Consolidation

Debt Consolidation summary:

• Debt consolidation involves getting one new loan or balance transfer credit card and using it to pay off multiple existing debts. 

• Your new loan will ideally have a lower interest rate than the debt you're consolidating.

• Combining multiple debts into one new one can simplify your finances by leaving you with only one monthly payment instead of many.

Debt Consolidation Definition and Meaning

Debt consolidation means repaying multiple existing debts with one new loan to simplify the debt repayment process.  

You can take out a personal loan, borrow against your home equity, use a specialized debt consolidation loan, or use a balance transfer credit card to consolidate your debt. 

The goals of debt consolidation could be any of these:

• Reduce the number of monthly payments you make

• Get a lower monthly payment

• Get a lower interest rate, which could lower the overall cost of the debt

• Move variable-rate debt to a fixed-rate loan

• Get a set payoff date for credit card debt you’ve been dragging around

• Lower your credit utilization ratio by moving credit card debt to an installment loan

Types of Debt Consolidation 

You can consolidate any kind of debt, including credit card debt, payday loans, medical debt, or student loans. Most people don’t consolidate secured debts like car loans or motorcycle loans because those often have lower interest rates compared to consolidation loans. 

You will need to get a new loan to pay off all the debts you want to consolidate. Here are some options to consider: 

• Personal loans: General personal loans can be used to consolidate debt. Banks, credit unions, and online lenders all allow you to apply for a personal loan that you could use for any purpose, including debt consolidation. 

• Home equity loans: Home equity is the difference between your home’s value and the amount you still owe on your mortgage. If you have enough equity, you might be eligible to borrow against it for debt consolidation. Home equity loans tend to have lower rates than personal loans or credit cards because they are secured loans, guaranteed by the home. If you don’t repay the loan, you could lose your home.

• Balance transfer credit cards: If you want to consolidate credit card debt, a balance transfer card is an option. Some balance transfer credit cards offer a 0% introductory interest rate that could last from 6 to 18 months. You’ll usually pay a fee for each balance that you transfer. Balance transfers don’t give you much time to pay off the consolidated debt.

The right choice depends on the type of debt you have and what options you qualify for based on your credit and income. 

Pros and Cons of Debt Consolidation

There are benefits and disadvantages to debt consolidation. 

Here are some of the biggest advantages:

• Having one monthly payment is simpler than managing multiple payments to many different lenders. 

• You can consolidate debt using a new loan or credit card with a lower rate

• You get more flexibility, as you can choose to consolidate into a loan with a shorter term to keep interest costs as low as possible or one with a longer term to reduce monthly payments as much as possible

Here are some of the biggest disadvantages. 

• You risk ending up deeper in debt if you consolidate existing debts and then borrow more. This is a common pitfall for people consolidating credit card debts.

• You may make total payoff costs higher if you stretch out your repayment term

• Some people think it’s a bad idea to pay off unsecured debt (like credit card balances) with a secured loan (like a home equity loan). That’s because credit card debt could be negotiated or even included in a bankruptcy. But mortgage debt, including home equity loans, can’t. If you’re a homeowner and you’re struggling financially, that’s something to consider. 

Explore your options to learn what kind of debt consolidation loan you might qualify for. That information will help you decide if this approach to managing your debt is right for you.