Pros and Cons of Debt Consolidation: Is It Worth It?

Debt consolidation is a commonly used strategy for combining and paying off multiple high-interest balances, usually through a balance transfer credit card, line of credit or personal loan. However, it's not the best solution if you can't qualify for a good interest rate or if you're too cash-strapped to manage the new loan. Here's a closer look at some of the pros and cons of debt consolidation.

Key Takeaways

• Debt consolidation works best when you're carrying multiple high-interest balances, can qualify for a lower annual percentage rate (APR) than your current debt and can commit to a repayment plan without taking on new credit during the payoff period.

• Common consolidation tools include personal loans, balance transfer cards, home equity loans and debt management plans, each with different rate ranges, fee structures and credit requirements. The right option depends on your credit score, how much you owe and how quickly you can repay.

• Fees and longer repayment terms can offset savings, especially where origination fees of 1% to 15% on personal loans and balance transfer fees of 3% to 5% add upfront costs. And stretching your repayment period lowers monthly payments but ultimately increases total interest paid.

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What Are the Pros and Cons of Debt Consolidation?

Debt consolidation can simplify your finances, but it comes with both benefits and potential drawbacks.

Pros

• Easier-to-manage debts: Debt consolidation allows you to combine multiple outstanding balances into one monthly payment, eliminating the number of accounts and bills you must juggle.

• Lower interest rates: People with good credit can often qualify for a low-interest loan, a favorable line of credit or a credit card with a 0% promotional APR, making debt more affordable in the long run. It can also help to understand the pros and cons of a personal loan when comparing your options.

• Reduced monthly payments: Lower interest rates typically result in lower monthly payments on installment loans. They also slow the growth of credit card balances.

• Faster payoffs: If you put the money you save on interest toward your balance and avoid new debts.

• Shored-up delinquent accounts: You can use a debt consolidation loan to pay off collections or past-due accounts, reducing late fees, penalty interest and costly credit report blemishes.

• Long-term credit score improvements: Getting out of debt and making timely payments on a debt consolidation loan will increase your creditworthiness over time.

Cons

• Upfront fees or penalties: Some loans carry origination fees or prepayment penalties, while balance transfer credit cards may charge a fee to move your debt from one card to another.

• Extended repayment periods: Longer repayment terms on a new loan can help reduce your monthly payment, though it's also possible that you'll end up paying more over the total life of the loan.

• Higher interest costs: There's no guarantee you'll qualify for a lower interest rate. And even if you do, keep in mind additional fees associated with borrowing could eat into your potential savings.

• Possible short-term credit score damage: Debt consolidation may affect your credit utilization, account age and new credit inquiries, three key factors that contribute to your credit score. However, not managing your debt can also damage your credit score.

• The strategy could backfire: Not making timely payments on a debt consolidation loan or running up new balances on old accounts could mean you risk accumulating more debt and further damaging your credit.

Is Debt Consolidation Right for You?

Debt consolidation can be a helpful strategy, but it’s not the right fit for everyone. Here’s how to decide:

When Does Debt Consolidation Actually Save You Money?

Debt consolidation can save you money if:

• You're already paying on multiple high-interest accounts

• You can stick to a repayment plan and pay on time

• You'll avoid taking on new debt during repayment

• You can qualify for a lower APR than your current debt

How Much Can You Save With Debt Consolidation?

Savings can vary based on your debt and loan terms. Here are some quick examples:

Balance Transfer

Eliminate future interest by transferring a $10,000 balance to a card with a 0% APR offer for 12 to 18 months and paying it off before the promotional period expires. Just note that, a 3% to 5% balance transfer fee will likely apply.

Personal Loan

Paying off credit card debt with a 24% APR using funds from a personal loan with a 12% APR can significantly reduce future interest costs. If you’re considering this route, it may also helpful to understand how debt consolidation loans work and how to find the best debt consolidation loans for your situation.

Will Debt Consolidation Hurt Your Credit?

Debt consolidation can have a negative impact on your credit, such as the following examples.

• Hard inquiry impact: Applying for a loan will likely trigger a hard inquiry on your credit report and slightly lower your credit score.

• Account age: Opening a new account can lower the average age of your credit accounts. Generally speaking, the longer you have credit the better.

• Credit utilization: Closing credit cards with high credit limits could increase your credit utilization rate, which is how much credit you’re using compared to your total available credit.

• Recovery timeline: Mismanaging your new credit, such as failing to make payments or running up a balance, will hurt your credit score in the long term.

With proper management, consolidating debt can help your credit score improve over time.

What Are the Most Common Debt Consolidation Options?

If you're weighing your options, it can be helpful to compare personal loans, HELOCs, balance transfers vs. other debt consolidation strategies side by side.

How Do You Choose the Right Debt Consolidation Option?

There are a number of ways to consolidate debt, here's how to make the best decision for your situation.

• Check your credit score: Balance transfer credit cards and personal loans with competitive APRs typically require a good credit score. If your financial profile is spotty, you might need to pursue a debt management plan, debt relief or bankruptcy.

• Compare loan terms, rates and fees: Most lenders advertise APR ranges, repayment periods and upfront fees on their websites. You can also ask about pre-qualification, where a lender uses a soft credit inquiry to provide conditional approval and rate estimates.

• Assess how much you owe and your ability to repay: Debt consolidation only works if you can make monthly payments and pay off the balance within the allotted time. For instance, you don't want to select a balance transfer credit card with a six-month introductory APR if you can't pay off your debts within that window.

• Consult a lender or credit counselor if you're unsure: They can provide more insights into different options and help you determine which products best fit your financial profile.

The Bottom Line

Debt consolidation can simplify your payments and lower your interest rate, but it only works if you stop adding new debt and can keep up with the new loan. Look closely at the fees, the rate and the payoff timeline before you sign. Done right, it turns a pile of bills into one clear path to zero. Done wrong, it just moves the debt around. Weigh the pros and cons against your budget and pick the option that gets you out of debt for good.

FAQs

Is debt consolidation a good idea?

Debt consolidation is often a good idea if you're looking to combine and pay off outstanding high-interest balances, and you can still qualify for favorable terms, a low interest rate, in particular, on a new loan.

Does debt consolidation hurt your credit?

Debt consolidation can hurt your credit in the short term, as it may generate a new hard inquiry, shorten the average age of your credit accounts and change your credit utilization rate. However, making timely payments and successfully lowering your outstanding balances through debt consolidation is likely to improve your credit in the long term.

When is debt settlement better?

Debt settlement might be better than consolidation options if you're falling behind on payments or if you’re seriously considering bankruptcy. If things are that bad, any damage a debt settlement might do to your credit score has likely already been done.

Key Terms

• Debt consolidation: The process of combining multiple debts, often high-interest credit card balances, into a single loan or credit line, ideally at a lower interest rate, to simplify repayment and reduce total interest costs.

• Balance transfer: The process of moving existing credit card debt to a new card, often one with a 0% introductory APR; balance transfer fees of 3% to 5% typically apply, and the promotional rate expires after a set period.

• Origination fee: A one-time upfront charge deducted from personal loan proceeds before disbursement; fees for consolidation loans typically range from 1% to 15% and should be factored into any total-cost comparison.

• Home equity loan/HELOC: Secured borrowing products that let homeowners tap the equity in their home as a lump sum (home equity loan) or revolving credit line (HELOC); they carry lower rates but use your home as collateral, creating higher risk if you default.

• Debt management plan: A structured repayment program set up by a nonprofit credit counselor who negotiates lower interest rates with your creditors.

• Hard credit inquiry: A formal credit check triggered when you apply for new credit; it may temporarily lower your score by a few points and stays on your credit report for up to two years.

Summary generated by AI, verified by MoneyLion editors

Sources

• CFPB: What do I need to know about consolidating my credit card debt?

• CFPB: What is the difference between credit counseling and debt settlement, debt consolidation, or credit repair?

• CFPB: What is a credit inquiry?

Jeanine Skowronski contributed to the reporting for this article.

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