Understanding debt consolidation

• If you’re struggling to pay multiple debts every month, debt consolidation may be right for you.
• You can use personal loans, balance transfer credit cards, or home equity to consolidate your debt.
• Addressing how you got into debt in the first place and establishing new habits is key.

When you’re in debt, it can feel impossible to get out from under the weight of it. If you’re looking for options to help you get out of debt and make repayment easier, debt consolidation may be right for you.

What is debt consolidation?

Debt consolidation takes a group of different debts you owe and turns them into one monthly payment. For example, let’s say you have a few credit cards, all carrying a balance. You’re tasked every month with making several payments, each at different amounts, with different due dates and different interest rates. It can be a lot to manage.

Debt consolidation can help make your payments and monthly bills more manageable. It helps you condense your debt into one simple payment. In some cases, you may be able to save money on interest if your loan’s interest rate is lower than the APR on your debts.

How debt consolidation works

If managing your payments has become difficult, you might consider debt consolidation. There are various tools you can use to consolidate your debt.

Debt consolidation methods

Personal loans

A personal loan is a flexible loan option that can be used for various personal reasons, including debt consolidation. Personal loans are typically unsecured, meaning that they are not backed by any type of collateral, like a home or a car.

Using a personal debt consolidation loan, you can pay off all your various debts then have just the personal loan to pay back. One perk with personal loans is that they typically have better interest rates than credit cards, so you could save money by using a personal loan if you have high-interest consumer debt. The best personal loan for you will depend on your credit score, which will determine what you qualify for and can lower your rate.

Balance transfer credit cards

Another option for debt consolidation if you have credit card debt is a balance transfer. A balance transfer is when you transfer the balance you have on various credit cards to one balance transfer credit card that has a lower interest rate (or, in some cases, a 0% interest rate).

The important thing to note here is that many of these low or 0% interest rates are promotional and only last a certain amount of time.

If you can pay off your debt in 15 months, or make a significant dent in your balance during that time, you can save money on interest and pay down debt faster.

You also want to be aware of balance transfer fees, which are typically 3% to 5% of your balance. Do the math to make sure doing a balance transfer is advantageous for you, and make sure to compare all the details of credit cards vs. personal loans.

Also, be mindful of having access to another credit card. If you haven’t addressed the spending issue that got you into debt in the first place, having a balance transfer credit card could lead you into more debt if you keep spending.

Home equity loan

If you’re a homeowner, you may be able to access a home equity loan as a tool for debt consolidation; a home equity loan allows you to borrow money against your house to pay off other debts.

Debt consolidation process

The basic process of consolidating debt is the same, whichever method you use:

1. Determine all of the debts you have. Some of the most common types are credit card debt, personal loans, medical debt, and student loans.
2. Choose which debts you want to consolidate.
3. Select a method for consolidating the debt.
4. Take out a new loan or credit line (whether a personal loan, balance transfer credit card, home equity loan, or other type).
5. Use the new loan to repay your old debts.
6. Pay off the new loan.

Evaluating if debt consolidation is right for you

Debt consolidation can be used to make debt repayment more manageable, and, in some cases, you could even save money on interest. It’s important to understand any associated costs or fees with the debt consolidation tools listed above. You want to read through the fine print and look at the terms and conditions.

Most importantly, address the reason you got into debt in the first place and come up with a plan to pay off your debt. If you don’t have a strategy in place, these tools could mean winding up in even more debt.

Debt consolidation FAQs

Will debt consolidation affect my credit score?

Debt consolidation can initially impact your credit score due to the credit inquiry from applying for a new loan. However, over time, it can positively affect your score by simplifying your payments and reducing your credit utilization ratio.

Is it possible to consolidate all types of debt?

Unsecured debts like credit cards and personal loans typically can be easily consolidated. Secured debts like mortgages are unlikely to be eligible for consolidation through typical unsecured debt consolidation loans.

How does a balance transfer credit card work for debt consolidation?

A balance transfer credit card allows you to transfer debts from multiple high-interest cards to a single card, often with a lower introductory interest rate. This can simplify monthly payments and reduce the total amount of interest you have to pay.

Are there any risks associated with debt consolidation?

Risks involved with debt consolidation include potentially higher overall costs if the borrowing you do to consolidate the debt has a longer term, even if the monthly payments are lower. It’s also important to not take on new debt after consolidation relieves some of the pressure of high monthly payments.

Can I consolidate my debt if I have a low credit score?

You can consolidate debt with a low credit score, but it may be more difficult to qualify. You’ll also face higher interest rates or need to secure the loan with collateral. Be sure to carefully evaluate the terms and ensure they are beneficial in the long term.

This article was written by insider@insider.com (Melanie Lockert) from Business Insider and was legally licensed through the DiveMarketplace by Industry Dive. Please direct all licensing questions to legal@industrydive.com.