How to Save the Most Money When Consolidating Debt

Debt consolidation could make your financial life a little easier if you'd like to have fewer bills to pay each month. When you consolidate debt, you use a loan to pay off credit cards, medical bills, and other debts. Once those debts are paid off, you're left with one monthly payment to make to the loan. 

That can be a stress-reliever, and there's another potential upside. You might be able to save money when you consolidate debt if your new loan has a lower interest rate and/or fewer fees. 

We've got some tips to help you maximize debt consolidation savings. 

How Much Could You Save With Debt Consolidation?

Your potential savings from debt consolidation hinges partly on interest rates fees. To figure out how much you could save, you'll compare what you currently pay to what you might pay with a debt consolidation loan. 

Here's an example. Let's assume that you owe $25,000 on credit cards, and your average annual percentage rate (APR) is 24.99%. You could choose from two debt consolidation loan options:

• $25,000 personal loan at 17.45%

• $25,000 home equity line of credit (HELOC) at 11.45%

The personal loan has a five-year repayment term. The HELOC has a five-year draw period followed by a 10-year repayment period. That means for the first five years, you'd have the option to borrow, repay, and borrow more, up to your credit limit, as often as you like. However, for this example, let’s just assume you don’t borrow more. Instead, you make a monthly payment that’s calculated to fully pay off your loan by the end of the repayment period (15 years).

Here's how the costs break down.

The HELOC lets you save money right now, which could bring welcome relief to your monthly budget. But the longer you take to repay a loan, the more interest you’ll pay. If you opt for the lower payment and longer repayment period, you’ll pay more overall. 

If, however, you opt for a HELOC with no prepayment penalty and you stay on a five-year track, the lower interest rate gives you both a lower monthly payment and a lower total interest cost.

Now, how much would you pay to your debt if you don't consolidate?

If you wanted to pay the credit card debt off in five years without consolidating, you'd need to pay $734 per month. You’d repay a total of $44,018. 

Tips to Save Money on Debt Consolidation

The money you save on debt consolidation is money you could use to fund your other financial goals. Here's how to consolidate debt and keep more of your hard-earned dollars. 

1. Decide what kind of loan makes sense

Personal loans and HELOCs can help you consolidate debt, but they work differently. 

• Personal loans are unsecured, which means they’re not tied to collateral or anything of value that you own. Unsecured debts usually have higher interest rates since they're riskier for lenders. 

• HELOCs are secured by your home. If you don’t repay the loan, you could lose your home. The lender could sell it to recover the money you owe. Since there's less risk for the lender, HELOCs can offer lower interest rates. A lower rate can mean a lower monthly payment. 

The examples we shared show how the cost of debt consolidation compares between a personal loan vs. a HELOC. Once you know what you might qualify for, you'll have to decide if it's more important for you to pay less interest overall or have a smaller monthly payment. 

2. Shop around

Once you know what kind of debt consolidation loan you want, check out what different lenders offer. Specifically, consider:

• Interest rates

• Fees

• Loan terms (and monthly payments)

Also, be on the lookout for rate discounts. You might find a rate discount for agreeing to automatic payments, or if you agree to borrow less or take a shorter repayment term. Even a fraction of a percentage point discount could give you significant savings.  

3. Improve your credit

Credit scores affect loan approval and interest rates. A higher score could help you snag a lower interest rate, which translates to more savings for you. 

You could improve your credit score when you:

• Pay bills on time or early

• Lower your debt and increase your credit limits

• Hold off on new applications for credit

What if you don't have time to wait for a boost in your score? You could apply for a debt consolidation loan with a co-signer or co-borrower. Lenders may be willing to offer lower rates if your co-signer has a solid credit history. 

4. Pay more than the minimum

When you get a debt consolidation loan, you'll have a set payment to make monthly, but you could speed up your payoff by adding to it. 

For example, if your regular payment is $600, you could pay $625 instead. Every extra penny you pay chips away at your principal, which is the original amount of the loan. For most loans, when you lower the principal, you pay less interest. 

You could also save money if you switch to biweekly payments instead of monthly. If you cut your monthly payment in half and pay every other week you'll end up with one full extra payment per year. 

That could shave a few months off your repayment term (and potentially a few hundred dollars on interest). Ask your lender if an early payoff will trigger a penalty fee, which could erase some of your savings. 

Save With Debt Relief Instead

If you mostly owe credit cards, medical bills, or other unsecured debts, you could try to resolve the debt to maximize savings. Debt relief or debt settlement means negotiating with your lender to accept less than what you owe (and forgive the rest).

Debt relief is perfectly legal, and plenty of people choose this option when they have a financial hardship that keeps them from paying in full. If you're interested in how debt relief could save you money, check to see if you qualify.