How does debt consolidation work?

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In a Nutshell

Debt consolidation can help you get multiple monthly payments under control by turning them into one single, predictable payment. But debt consolidation isn’t a get-out-of-debt-free card — you’ll need to have good spending habits to stay debt-free.

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If you’re overwhelmed by your debt and having trouble managing a bunch of monthly payments, debt consolidation may be an option to help take control of your finances.

Household debt in America rose to a record $13.86 trillion in the second quarter of 2019, according to the Federal Reserve. The average American family may be trying to juggle credit card, student loan, mortgage, auto and personal loan debt. Debt consolidation offers a way to bundle a number of outstanding debts into one monthly payment, which may help you manage your finances more efficiently.

Let’s dive into the specifics of debt consolidation and find out if it could be a good move for you.


What is debt consolidation?

Debt consolidation is a way to combine a number of outstanding debts into a single loan with one monthly payment.

If you’re able to consolidate your debt into one loan with a lower overall interest rate, it may help you save on interest charges and pay off your debt faster. But consolidation doesn’t eliminate or forgive your debt. And keep in mind that even with a potentially lower interest rate, you may end up paying more over time because some debt-consolidation loans have longer terms than those for the multiple debts you’re repaying.

If you’re struggling to stay on top of your bills, here are a few things to do before taking out a debt-consolidation loan.

  • Reach out to your creditors to explain your situation and see if they can accept lower payments, cut any fees or reduce your interest rate. You may also be able to arrange the same due date for monthly payments across all of your debts, simplifying your finances.
  • Speak with a certified credit counselor.
  • Beware of debt-settlement companies that charge fees to negotiate your debt.

Common ways to consolidate debt

There are several options to choose from if you decide to move forward with debt consolidation. The type and amount of your debts should figure into your choice.

Balance transfer

Many credit cards offer promotional periods with 0% interest on balance transfers. If you’re approved for a balance transfer card, you may have the opportunity to transfer several debts onto  one card to repay your debt at 0% interest for a limited time.

But before you make a balance transfer, make sure you understand exactly when and how your new card will start charging you interest. Look out for balance transfer fees and note that depending on the card, any new purchases you make on your card may not be subject to the promotional interest rate. And it’s important to make a plan for tackling your debt during the interest-free period and making sure it doesn’t get out of hand again.

Additionally, before you start transferring balances to a new card, make sure to check the card’s credit limit. You’ll want to think through which debts you’re transferring to the card because the credit limit may be lower than your combined debts or eat into too much of your available credit.

Personal loan

Personal loans are offered by many lenders including banks, credit unions, and online lenders. You can use personal loans to finance weddings, vacations and medical bills — and to consolidate debt.

Debt-consolidation loans are installment loans that roll your qualifying debt into one monthly payment. A debt-consolidation loan may be a smart way to manage your finances, because you’ll know what you need to pay each month and for how long.

Before you move forward with a personal loan, make sure to understand the terms and fees, which may increase the total amount you pay back.

Home equity line of credit

Another option for debt consolidation is applying for a home equity line of credit, or HELOC. This may be the riskiest option because you’ll have to put your home up as collateral. If you’re unable to keep up with payments, you may lose your home.

Though interest rates on home equity loans may be lower than other debt-consolidation options, make sure to take the risk of losing your home into account before opting for a HELOC.

Is debt consolidation right for you?

If you’re struggling to manage multiple debt payments and are ready to buckle down on your spending habits, debt consolidation may be worth considering. Before you commit to a plan, take a closer look at your finances.

Debt consolidation might be a good idea if …

  • You understand why you’re in debt and are focused on controlling your spending.
  • You want to reduce the number of monthly payments you manage.
  • You have a credit history that will help you qualify for a lower-interest personal loan or a credit card with an introductory 0% APR on balance transfers.
  • Your current income can cover the debt payment and any other bills you may have. If it doesn’t, you risk running into more financial difficulties down the road.

Debt consolidation might not be for you if …

  • You can’t change your spending habits right now.
  • You have a small amount of debt that could be repaid quickly.
  • Your credit history might stop you from getting a low-interest personal loan or promotional balance transfer APR.

What’s next?

Debt consolidation may not solve all of your financial woes, but it could be a good step if you’re able to stick to a debt-management plan. Consider consulting with a certified credit counselor or a certified financial planner who may be able to help you tackle your debt and make financial progress.