Debt Consolidation: How It Works and Whether It's Worth It

Debt consolidation means combining multiple debts into one loan or payment, ideally with a lower interest rate and one monthly due date. It can help you save money and simplify repayment, but only if the new rate, fees and payoff timeline actually improve your situation.

• Who it's best for: Borrowers with steady income who want to tackle high-interest debt.

• Not ideal if: You're still accumulating debt or you don't qualify for a lower rate.

• What to keep in mind: You should only consolidate your debt if you can get a lower annual percentage rate (APR) than your current average rate. Avoid getting one if it extends your payoff timeline.

Before taking out a consolidation loan to pay off debt, read on to learn more about debt consolidation and a suggested offer from Accredited Debt Relief.

MoneyLion

Which of the following is an example of installment credit?

Credit cardAuto loanStore cardGas card

6

MoneyLion offers a service to help you find personal loan offers based on the info you provide, you can get matched with offers for up to $50,000 from our top providers. You can compare rates, terms, and fees from different lenders and choose the best offer for you. You can also use the loan funds to pay off other existing debts. MoneyLion is here to help.

Key Takeaways

• Debt consolidation rolls multiple debts into one payment, ideally at a lower rate. It can simplify credit cards, personal loans and medical bills, though federal student loans and tax debt usually don't qualify.

• You only save money if your new rate beats your current average. Watch for origination fees, balance transfer fees and longer terms that can quietly erase the benefit.

• Consolidation works best with steady income and a real payoff plan. Without one, or if you keep adding new debt, it can leave you deeper in the hole.

• Most lenders want at least a 580 FICO score to qualify. Personal loan APRs for consolidation typically range from about 6% to 36% depending on your credit.

• A new loan can dip your score before it helps it. A hard inquiry and lower average account age hurt short term, but on-time payments build your history over time.

Summary generated by AI, verified by MoneyLion editors

What Is Debt Consolidation?

Debt consolidation brings multiple debts into one place so you only have one payment, one due date and one interest rate to manage.

You'll have only one:

• Loan to deal with

• Monthly payment to make

• Interest rate to keep in mind

Debts you can typically consolidate:

• Credit card balances

• Personal loans

• Medical bills

• Car loans

Debts you can't usually consolidate:

• Federal student loans

• Tax debt

• Child support

Why is this helpful? Imagine you have debts with different due dates and interest rates. It can get overwhelming trying to remember when each payment is due and how much interest you're paying for each debt. Debt consolidation solves that problem by combining everything into a single loan.

Not only does debt consolidation make things simpler, but it can also save you money by potentially getting you a lower interest rate on the consolidated loan.

When you have multiple debts, each with its own interest rate, you might end up paying more in total interest. But with debt consolidation, you have a chance to secure a better interest rate, which can reduce the overall amount of interest you’ll pay over time. It’s like getting a discount on your debts.

How Debt Consolidation Works

Here's how debt consolidation works:

1. Instead of making separate payments for each debt, you take out a new loan or credit card specifically for consolidating your debts.

2. This loan or card has a fixed interest rate and a set repayment period.

3. With this new loan or card, you pay off all your other debts, leaving you with just one monthly payment to make.

Debt consolidation can have positive and negative effects, depending on how you manage it.

Debt consolidation alone doesn't magically fix your credit. You’ll want to practice good financial habits, such as making payments on time and not accumulating more debt, to maintain a healthy credit profile.

Ways To Consolidate Debt

There are a few different ways to consolidate your debt. The best one will depend on your individual circumstances.

Personal Loans

You can get a personal loan from a bank or online lender to consolidate your debts. This loan is used to pay off your existing debts, and then you make regular payments on the personal loan instead.

Balance Transfers

Some credit card companies offer balance transfer options. This involves transferring your existing credit card balances to a new credit card with a low or 0% introductory interest rate for a specific period. You make payments on the new card to consolidate your debts.

Home Equity Loans

If you own your home and have some equity in it, a home equity loan may be an option to explore. These loans use your home value as collateral but do have credit and income requirements to qualify. 

DMP

These programs are typically offered by credit counseling agencies. They work with your creditors to negotiate lower interest rates or reduced monthly payments. You make one monthly payment to the credit counseling agency, which distributes the funds to your creditors.

Debt Consolidation Loans

Similar to personal loans, debt consolidation loans are specifically designed for consolidating debts. You apply for a loan from a bank or lender, and if approved, you use the funds to pay off your existing debts. Then you make regular payments on the consolidation loan.

Keep in Mind

These options have their pros and cons, so you’ll want to consider which one aligns best with your needs and goals. Take your time to explore each method and compare interest rates, fees and eligibility requirements. 

5 Benefits of Debt Consolidation

Debt consolidation offers several benefits that are worth exploring. 

1. Chance To Simplify Repayment

By consolidating your debts, you combine them into a single loan or payment. You only need to keep track of one due date and one interest rate, which can make it easier to stay organized and avoid missed payments.

2. Possible Lower Interest Rates

The potential to nab a lower interest rate for your debts is a huge perk, especially if you're dealing with high-interest credit card debt or payday loans.

Certain types of debt often come with sky-high interest rates, which means you end up paying more money in the long run. But with debt consolidation, you have a chance to renegotiate and get a better deal.

3. Possibly Reduced Monthly Payments

Consolidating your debts can potentially lower your monthly payment amount. For example, you may secure a lower interest rate on the consolidated loan, resulting in a reduced monthly payment.

Extending the repayment term can spread out the payments over a longer period, which can make them more affordable each month. Lower monthly payments can provide immediate financial relief and free up some of your budget for other expenses or savings.

4. Debt Payoff Strategy

Debt consolidation allows you to simplify your debt repayment strategy. Instead of feeling overwhelmed by multiple creditors, due dates, and many different interest rates, you can focus on a single loan.

You can create a clear plan to pay off your debt systematically. You can allocate your resources more effectively, potentially paying down the debt faster and regaining financial control.

5. Opportunity To Improve Your Credit Score

Debt consolidation can have positive effects on your credit score. It can lead to a lower credit utilization ratio by increasing your available credit, potentially counteracting any negative impact from opening a new account.

Making timely payments on your new loan can gradually improve your payment history, which plays a big role in your overall credit score. However, you'll still have to demonstrate that you're responsible with your finances and be consistent with your payments to experience these benefits.

Finally, it's important to note that when you first open a new account, you might see a slight decrease in your credit score.

3 Potential Drawbacks of Debt Consolidation

Debt consolidation is not a magical solution that automatically solves all your financial problems. It requires careful consideration and planning to ensure its effectiveness. Here are a few risks to be aware of.

1. Temptation To Accumulate New Debt

One drawback is the temptation to continue using credit cards or taking on new loans without addressing the underlying spending habits and financial discipline.

If you fall into this trap, you might end up with even more debt than before, defeating the purpose of debt consolidation.

2. Extended Repayment Period

Debt consolidation can sometimes result in a longer repayment period compared to your original debts. While it can lower your monthly payments, it may mean that you end up paying more overall due to the extended duration of the new loan.

Evaluate the trade-off between lower monthly payments and the total cost of the extended repayment period.

3. Potential for Higher Total Interest Paid

Depending on the interest rates and terms of the consolidation loan, there is a possibility that you may end up paying more in total interest compared to your original debts. This is particularly true if you extend the repayment period or opt for a consolidation loan with a higher interest rate.

Make sure you compare the total interest costs of your current debts with the projected interest costs of the consolidation option. 

Factors To Consider Before Consolidation

If you need a cheat sheet for what to think about before you consolidate your debt, take a look at the following:

Good candidate for debt consolidation if:

• You know your exact total debt amount.

• Your new rate is lower than your current average rate.

• Your new loan would extend your repayment term unnecessarily.

• Fees are reasonable — less than 5% origination and balance transfer around 3% to 5%.

• Your income is steady.

Take a closer look if:

• The new interest rate is the same or higher.

• Your repayment terms increase the interest you end up paying.

• The fees could zero out any savings you gain.

• Closing credit card accounts or opening new ones can affect your credit utilization ratio or credit history length.

Should You Consolidate Your Debt?

Debt consolidation makes the most sense when it lowers your borrowing costs, simplifies repayment and fits into a realistic payoff plan. If it won't reduce your interest costs — or you're likely to continue adding new debt — it may be worth exploring other repayment strategies first.

Bottom Line

• Compare your current average APR with any consolidation offer.

• Calculate the total cost, including fees and interest.

• Choose a repayment method that keeps you from adding new debt.

• Consider nonprofit credit counseling if consolidation won’t lower your cost.

FAQs

Is debt consolidation the right choice for everyone?

Debt consolidation may be suitable for some, but it's not always the right solution for everyone. It depends on factors such as your financial situation, goals, and personal preferences.

What are the risks of debt consolidation?

Debt consolidation risks include the temptation to accumulate new debt, the potential for an extended repayment period that increases overall costs, and the possibility of paying more in total interest. As long as you plan for your expenses well and avoid incurring additional fees according to the terms of your agreement, you can bring that risk down.

Can I consolidate all types of debt?

Debt consolidation options typically include credit card balances, personal loans, medical bills and other unsecured debts. However, certain types of debt, such as mortgage loans or federal student loans, may have specific consolidation programs or restrictions. Check the eligibility criteria and terms for each type of debt you wish to consolidate.

Should I close my credit cards after consolidating debt?

Not necessarily. Keeping older credit card accounts open can help maintain your available credit and length of credit history, both of which influence your credit score. If you're worried about overspending, consider leaving the accounts open but avoiding new purchases or removing the cards from your wallet.

Key Terms

• Debt consolidation: Combining multiple debts into a single loan or payment, ideally at a lower interest rate, to simplify repayment and reduce total interest.

• APR: The yearly cost of borrowing, including interest and certain fees, shown as a percentage so you can compare the true cost of loan offers.

• Balance transfer: Moving existing credit card debt to a new card, often with a 0% intro rate, to cut interest during the promotional period. A 3% to 5% transfer fee usually applies.

• Credit utilization ratio: The share of your available revolving credit you're using. Keeping it below 30% generally helps your score.

• DMP: A structured repayment plan set up through a nonprofit credit counselor, who takes one monthly payment and distributes it to creditors, sometimes at negotiated lower rates.

• Origination fee: A one-time upfront charge, often 1% to 10% of the loan, that a lender deducts from your funds before disbursing the loan.

• Home equity loan: A loan against your home's equity that can carry a lower rate than unsecured debt but puts your home at risk if you default.

Summary generated by AI, verified by MoneyLion editors

Sources

• Consumer Financial Protection Bureau. 2023. "What Do I Need To Know About Consolidating My Credit Card Debt?"

• Consumer Financial Protection Bureau. 2024. "What Is the Difference Between Credit Counseling and Debt Settlement, Debt Consolidation, or Credit Repair?"

• Federal Trade Commission. "How To Get Out of Debt."

• myFICO. "What Is a Credit Score?"