Getting into debt can happen gradually. Perhaps you open a credit card account or two, and take out a personal loan. Throw in your student loans and a car payment, and before you know it, you’ve got more debt obligations than you can manage.
It’s easy to get overwhelmed, but there is a possible solution: debt consolidation.
In This Article
What Is Debt Consolidation?
In a nutshell, consolidating debt means taking multiple debts and combining them into a single loan or line of credit. This can help make your debt load more manageable so that you can work on paying down what you owe.
When debts are consolidated, you have one single payment to make toward the balance each month. You pay one interest rate, which can be fixed or variable depending on how your debts are combined.
Assuming you’re not adding to your debt, consolidating is a strategy that can help you get ahead financially.
What Kinds of Debt Can You Consolidate?
You may have more than one kind of debt and be wondering which ones you can consolidate. The good news is consolidation can cover many different types of debt. Here are some of the most common:
- Student loan debt — If you took out multiple student loans to pay for your education, then consolidating can be a good way to get a handle on your payments. Consolidating can whittle your loans down to just one loan servicer. It’s important to look for a lender that allows you to consolidate your loans with the best terms overall.
- Medical debt — Consolidating medical bills into a single loan can be particularly helpful if you have a large medical debt related to an unexpected illness or injury that your insurance and/or emergency savings doesn’t cover.
- Credit card debt — Credit cards often come with high interest rates. By consolidating your credit card debt, you can get a lower rate on your balance if you qualify for a credit card with 0% annual percentage rate (APR).
Aside from credit cards, student loans, and medical bills, there are a few other types of debt you can consolidate, like retail store credit cards, secured and unsecured personal loans, collection accounts, and payday loans.
Best Way to Consolidate Debt
The great thing about debt consolidation is that you have more than one way to do it. The two primary ways to consolidate debt are:
- Transferring a balance to a credit card with a 0% APR.
- Combining balances using a debt consolidation loan.
In addition to the above, you can also take out a home equity loan or 401(k) loan — though these methods are far riskier.
What matters most is choosing the option that’s right for you and your budget. As you’re comparing consolidation methods, it also helps to know how they work and what the benefits are, especially when it comes to your credit score.
Read on to learn more about balance transfers, debt consolidation loans, and other types of debt management programs.
Balance Transfer Credit Card
A balance transfer, also known as credit card refinancing, means moving the balance you owe on one credit card to another credit card. Ideally, you’re shifting the balance to a card with a low or 0% APR.
A balance transfer credit card can be a good way to manage debt consolidation if your credit score allows you to qualify for the best transfer promotions. Plus, if you get a 0% rate for several months, this may give you enough time to pay off your debt in full without interest.
When comparing balance transfer credit card promotions, it’s helpful to check your credit score so you know which cards you’re most likely to qualify for. Then, check the terms of the promotional offer so you know what the APR is and how long you can enjoy an interest-free period.
A personal loan is a loan that can meet different financial needs, including consolidating debt. Personal loans are offered by banks, credit unions, and online lenders.
Every personal loan lender differs in how much they allow you to borrow and the rates and fees they charge. The rate terms you qualify for will hinge largely on your credit score and income.
Some personal loans are unsecured. This means you don’t need to give the lender any collateral to qualify. A secured personal loan, on the other hand, requires you to offer some kind of security — such as a car title or money in your savings account — in exchange for a loan. You’d get your collateral back once the loan is paid off.
Home Equity Loan
If you’re a homeowner, and have equity in your house, you may be able to take out a home equity loan or line of credit (HELOC) to get cash and use it toward your other debts.
There are two types of home equity loans: a fixed-rate, lump-sum option, and a HELOC, which acts like a credit card with a variable interest rate.
Since the loans are secured by your house, you’re likely to get a lower rate than what you would find with a personal loan or balance transfer credit card. However, you can also lose your home if you don’t keep up with payments.
If you participate in an employer-sponsored retirement account such as a 401(k), you can borrow that money in the form of a loan, and use the funds to pay off your debts. There’s no credit check, the interest rate is low, and the repayment is deducted from your paycheck.
However, once you take out the funds from your 401(k), you will lose out on any compound interest you could have earned from allowing your account to grow. And if you’re unable to make your payments, the amount you withdraw could be taxed, and on top of that, you might have to pay an early withdrawal penalty.
Debt Management Programs
Debt management plans or debt management programs are not loans. These programs help you to consolidate and pay down your debt by working with your creditors on your behalf.
A debt management plan works like this:
- You give the debt management company information about your creditors, including the amounts owed and minimum monthly payment.
- The debt management company negotiates new payment terms with your creditors.
- You make one single payment to the debt management company each month.
- The debt management company then divvies up that payment to pay each of your creditors.
- The process is repeated each month until your debts are paid off.
A debt management program can be a good choice if you don’t want to take a loan or transfer a credit card balance. Your debt management company can help you combine multiple payments into one. They may even be able to negotiate a lower interest rate or the waiver of certain fees.
The downside is that debt consolidation services may only apply to credit card debts. So, if you have student loans or other debts to consolidate, you may not be able to enroll them in the plan.
Pros and Cons of Debt Consolidation
Debt consolidation can offer several advantages, but it can also come with a myriad of drawbacks. If you’re considering debt consolidation, take a look at these pros and cons:
|You can end up with a lower interest rate.||Any method of debt consolidation could come with fees, including origination fees, annual fees, balance transfer fees, closing costs, and late payment fees.|
|You may save money. When you have a lower interest rate, you’ll pay less in interest, saving money in the process.||Depending on how your loan is structured, your debt consolidation loan could come at a higher rate than what you currently pay on your debts.|
|You’ll have a single payment. Keeping up with one loan payment each month is easier than trying to juggle multiple payments.||If you use any type of secured loan to secure your debt, such as a home equity loan or HELOC, you could lose your collateral should you fall behind on payments.|
|Your payment may be lower. Consolidating your debt can help you get a lower combined payment.||Your credit score can severely suffer if a lender reports a late payment to the credit bureaus after it becomes 30 days past due.|
Is Debt Consolidation a Good Idea?
Debt consolidation can be advantageous for certain people, depending on their unique circumstances. It’s important to do your research thoroughly to understand what debt consolidation can and can’t do for you.
Debt consolidation may not be the best way to handle debt in every situation. Here are some scenarios where you might want or need to consider a different debt repayment option:
- You don’t have enough income to make the monthly minimum payment required for a debt management program.
- Your credit score isn’t good enough to qualify for a low-rate credit card balance transfer or personal loan.
- You’re worried that applying for a new loan or credit card could knock more points off your credit score.
- Consolidating debt would mean paying fees or upfront costs that would only add to what you owe.
- You’re not able to consolidate all the debt you have in one place.
- Your debt load is too high, and filing for bankruptcy may make more sense.
- You have the income to pay down debt, but you just need a plan.
Credit card refinancing vs. debt consolidation: what’s the difference?
Debt consolidation and credit card refinancing are two of the most common ways to reduce credit card debt.
Credit card refinancing, also known as a balance transfer, is the process of moving a credit card balance from one card to another for a more favorable interest rate. This method is all about lowering your interest rate.
Credit card debt consolidation, on the other hand, is all about moving several credit card balances over to a single loan with one monthly payment. This is most commonly done through the use of a personal loan with a fixed term, giving you a set time, and a set interest rate, to pay off your credit cards.
Does debt consolidation hurt your credit?
If you’re merging your debts together by opening a new credit card or taking out a loan, you may see a slight dip in your credit score initially, due to a lender or card issuer doing a hard credit inquiry on your credit report.
Over time, however, you could see your score rise if consolidating allows you to pay down your debt faster. Having just one payment could also give your score a boost if you’re consistently making that payment on time every month.
Debt consolidation vs. bankruptcy: what’s the difference?
Debt consolidation and bankruptcy are popular debt management strategies.
When you consolidate your debts, you reorganize multiple debt payments into one payment.
On the other hand, bankruptcy eliminates or restructures your debts while under the protection of the federal bankruptcy court. Bankruptcy eliminates debts, but it puts a major stain on your credit history for 7 to 10 years.
What is a debt consolidation loan?
A debt consolidation loan is a personal loan used to consolidate multiple debts into one fixed monthly payment.
How do I get a debt consolidation loan?
To get a debt consolidation loan, take the following steps:
- Check your credit score and reports.
- Determine how much money you need to borrow.
- Review different online lenders, or banks, and credit unions to see eligibility requirements, loan terms, and fees.
- Get prequalified.
- Apply for your debt consolidation loan online, in person, or by phone.
- Receive funds and use them to pay off your existing creditors.
- Repay the debt consolidation loan as agreed.
Paying off debt can take time, and it’s important to stay committed and consistent. While you’re working on your debt payoff, remember to look at your bigger financial picture. This includes budgeting wisely and growing your savings.
Chime has tools that can help you with both. You can use Chime mobile banking to stay on top of your spending and stick close to your budget. Setting up direct deposit from your paycheck into your savings or establishing an automatic transfer¹ from checking to savings each payday can put you on the path to growing wealth.