What is debt consolidation? | The bank rate

Even if you work hard to manage your money the right way, paying off high-interest debt monthly can keep you from reaching your financial goals. No matter how much you owe, it can take months or even years to get out of it.

One way to manage multiple debt payments is to consolidate. Debt consolidation is a form of money management where you pay off existing debts by taking out a new loan, usually through a debt consolidation loan, balance transfer credit card, a student loan refinance, home equity loan or HELOC. Here’s what you need to know about debt consolidation and which method might work best for you.

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Definition of debt consolidation

Debt consolidation consists of merging several debts into one. Instead of making separate payments to multiple credit card issuers or lenders each month, you consolidate them into one payment from a single lender, ideally at a lower interest rate.

You can use debt consolidation to merge several types of debt, including:

  • Credit card
  • Medical debt
  • Personal loans
  • Student loans
  • Car loans
  • Payday loans

Although debt consolidation does not wipe out your balance, the strategy can make paying off debt easier and less expensive. If you get a low interest rate, you could save hundreds or even thousands of dollars in interest. Managing one payment can also make it easier to control your bills and avoid late payments, which can hurt your credit.

Types of debt consolidation

No matter what type of debt you are consolidating, if you are looking for how to consolidate your debts, you have several options to choose from.

debt consolidation loan

Debt consolidation loans are personal loans that consolidate multiple loans into one fixed monthly payment. Debt consolidation loans typically have terms between one and 10 years, and many will allow you to consolidate up to $50,000.

This option only makes sense if the interest rate on your new loan is lower than the interest rates on your previous loans.

Best for: Borrowers who want a fixed repayment schedule.

Balance transfer credit card

If you have multiple credit card debts, a balance transfer credit card can help pay off your debt and lower your interest rate. Like a debt consolidation loan, a balance transfer credit card transfers multiple streams of high-interest credit card debt to a single credit card with a lower interest rate.

Most balance transfer credit cards offer a 0% APR introductory period, which typically lasts 12 to 21 months. If you manage to pay off all or most of your debt during the introductory period, you could potentially save thousands of dollars in interest payments.

However, if you have a large outstanding balance after the period ends, you could find yourself more in debt, as balance transfer credit cards tend to have higher interest rates than other forms of debt consolidation. debts.

Best for: Borrowers who can afford to pay off their credit cards quickly.

Student Loan Refinance

If you have high-interest student loan debt, refinancing your student loans could help you get a lower interest rate. Student loan refinancing allows borrowers to consolidate federal and private student loans into one fixed monthly payment and on better terms.

Although refinancing can be a great way to consolidate your student loans, you will still need to meet the eligibility criteria. Additionally, if you refinance federal student loans, you will lose federal protections and benefits, such as income-contingent repayment and deferment options.

Best for: Borrowers with high interest private student loans.

Home Equity Loan

A home equity loan, often referred to as a second mortgage, allows you to tap into the equity in your home. Most home equity loans have repayment periods of between five and 30 years, and you can usually borrow up to 85% of the value of your home, less any outstanding mortgage balance.

Home equity loans tend to have lower interest rates than credit cards and personal loans because they are secured by your home. The downside is that your home is at risk of foreclosure if you fail to repay the loan.

Best for: Borrowers with a lot of equity in their home and a stable income.

Home equity line of credit

A home equity line of credit (HELOC) is a home equity loan that acts as a revolving line of credit. Like a credit card, a HELOC allows you to withdraw funds as needed with a variable interest rate. A HELOC also taps into the equity in your home, so the amount you can borrow depends on the equity in your home.

A HELOC is a long-term loan, with an average drawdown period – the period during which you can withdraw funds – lasting 10 years. The repayment term can be up to 20 years, during which time you can no longer borrow from your line of credit.

Best for: Borrowers with high equity in their home and wanting a long repayment period.

How to consolidate your debt

If you’re trying to figure out how to consolidate your debt, the process is pretty similar regardless of what form of debt consolidation you use. It is important to understand that debt consolidation is different from debt settlement. With debt consolidation, you will use the funds from your new debt consolidation loan to pay off all your existing debts in full.

Once you have secured the funds for your personal loan, home equity line of credit, or other debt consolidation loan, you can begin the debt consolidation process. Use these funds to pay off all your existing debts. You will then only have one monthly loan payment, usually with an interest rate lower than all the interest rates of your previous loans.

Advantages and disadvantages of debt consolidation

Debt consolidation is not the right choice for everyone; before consolidating your debt, consider the pros and cons.


  • Pay less total interest. If you can consolidate multiple debts with double-digit interest rates into one loan with an interest rate below 10%, you could save hundreds of dollars on your loan.
  • Simplify the debt repayment process. It can be difficult to keep track of multiple credit card or loan payments each month, especially if they are due on different dates. Taking out a debt consolidation loan makes it easier to plan your month and control payments.
  • Improve your credit score. You might see an increase in your credit score if you consolidate your debt. Paying off credit cards with debt consolidation could lower your credit utilization rate, and your payment history could improve if a debt consolidation loan helps you make more on-time payments.

The inconvenients

  • Pay initial fees. Any form of debt consolidation may incur fees, including origination fees, balance transfer fees, or closing costs. You’ll want to weigh these fees against the potential savings before applying.
  • Putting the warranty at risk. If you use any type of secured loan to secure your debt, such as a home equity loan or a HELOC, that collateral can be seized in the event of a late payment.
  • Could increase the total cost of debt. Your savings potential with a debt consolidation loan largely depends on the structure of your loan. If you have a similar interest rate but choose a longer repayment term, for example, you’ll end up paying more interest over time.

When debt consolidation is a good decision

Debt consolidation works best when the debts you have are mostly from a past situation that no longer applies to your life. Examples might include past medical debt, student loans, or debt you accumulated before you got your life under control.

In this case, debt consolidation can make a lot of sense. You can take these existing debts that often come with high interest rates and combine them into one monthly payment. You may also qualify for a lower interest rate, especially if you use a secured loan such as a home equity loan or home equity line of credit.

When You Shouldn’t Consider Consolidating Your Debt

Debt consolidation can help you save money on interest and pay off your debt faster, but it doesn’t solve the underlying reason you got into debt. Before consolidating, consider the internal and external factors that led to your current situation.

It is possible to consolidate your debts if you have already gone through debt consolidation, but it is not ideal. Debt consolidation works much better when you’ve fixed the underlying reason you got into debt in the first place. Ensuring that these root causes are addressed will help make debt consolidation a successful experience for you.

Key points to remember

If you’re interested in debt consolidation, make sure you’ve looked at the underlying reasons for how you got into debt in the first place. If you’re in a more stable place but got into debt earlier in your life, debt consolidation can make a lot of sense. Take the time to consider all of your options and get quotes from several lenders, including credit unions, online banks, and other lenders. Compare interest rates, fees and terms before finalizing your decision.

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