Pros and cons of debt consolidation

Should you consolidate your debt?

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Debt is a reality for most of us, whether it’s from credit card bills, medical bills, car loans or all of the above. Trying to juggle the different repayment terms and monthly payments can be overwhelming. Debt consolidation can be the answer to this problem. By combining two or more sources of debt into a single bill with a better interest rate and terms, you can simplify your finances and get out of debt faster.

Key insights

  • Debt consolidation streamlines the repayment process by combining two or more debt bills.
  • With a lower interest rate, you can pay off your debt faster and save money.
  • Debt consolidation is not debt elimination; you still have to tackle your dues.

What is debt consolidation?

Debt consolidation is the combining of two or more sources of debt into one manageable monthly payment. The most popular debt to consolidate is credit card debt because card annual percentage rates (APRs) are typically higher than other loans. Additionally, it makes sense to consolidate personal loans and medical bills when you can reduce your interest rate.

Mortgages, auto loans and student loans should not be included in your debt consolidation plan. These types of debts are better to refinance separately for a better rate if you want to lower your monthly payments.

When does debt consolidation make sense?

The goal of debt consolidation is to give you the upper hand financially. By combining your debts, you should feel in charge of your debt rather than crushed by it. Having one manageable payment means you can pay on time and make meaningful progress toward your debt freedom goals. One main payment will also help your credit score, because you’re able to establish a history of on-time, in-full payments.

When you consolidate your debt, it's not a bad idea to challenge yourself to beat your payoff date — and become debt-free faster.

You can look at your credit card and other unsecured debt, like personal loans, and decide whether or not debt consolidation is right for you. The goal is to combine these debts into one loan with a manageable monthly payment. But you should also be aiming to lower your borrowing costs. For example, it would be unwise to transfer a 12-month personal loan to a 48-month repayment term because you will be paying more interest in the long run.

To figure out if debt consolidation is the right choice, you’ll want to list out your debts, loan APRs, monthly payments and years left of repayment. However, if your total debt is less than $1,000, you might want to tackle it without consolidating. You don’t want to increase your debt burden by consolidating amounts that may be paid off quickly by taking a few months to throw any extra funds at those balances.

» MORE: How does debt consolidation work?

Advantages of debt consolidation

Debt consolidation can be a helpful tool to empower you financially. When your debt load is lighter, you can do more fun things with your money — including going on vacation, buying a new toy you’ve been wanting or saving for bigger goals. Other top perks of debt consolidation include:

  • One manageable monthly payment: Instead of trying to remember to pay every bill on time, you only have to worry about one monthly bill.
  • Fixed repayment schedule: Credit cards are a revolving line of credit and don’t have payoff dates. Switching debt to a fixed term means you know you will pay off your debt in 24, 36 or 48 months.
  • Pay off debt faster: Ever feel like you are throwing all your money at debt only to see no progress? With consolidation, you might have more available funds to pay toward debt and see it decrease faster.

Disadvantages of debt consolidation

Just like with most financial choices, debt consolidation does have downsides.

“There are several factors that must be considered when consolidating debt, i.e., amount, interest rate, term, total indebtedness and type of debt,” said Roslyn Lash, an accredited financial counselor. She also warned that your monthly payments may still be too high for you to pay even after consolidation.

Debt consolidation loans do come with origination fees — typically 1% to 8% of the total loan.

Debt consolidation is not free. Some lenders charge an origination fee for a debt consolidation loan. You’ll want to ensure you take this into account before consolidating your debt. You should always check with your specific lender to verify loan costs.

To save money on origination fees, you might not want to consolidate anything under $1,000. It’s usually cheaper to pay off those debts individually.

A word of caution: Because individuals with high amounts of debt are typically eager to escape it, many scammers and predatory lenders will take advantage of them. Stay away from payday loans and other lenders that promise quick payouts without credit score or income verification.

Alternatives to debt consolidation

Taking out a debt consolidation loan is not the only option to pay off your debt. For example, if you own a home, you might have equity that can be used to tackle debts. Here are a few alternatives to a consolidation loan:

  • Credit card balance transfer cards
  • Home equity line of credit or home equity loan
  • Cash-out refinance
  • Debt settlement

It’s important to check your finances and decide which option is right for you before jumping into a financial fix.

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Is debt consolidation or bankruptcy right for me?

Debt consolidation can be a great way to avoid bankruptcy. Bankruptcy is usually a last resort for people who have exhausted their options. Before you decide which option is right for you, talking to a financial advisor can be helpful to determine which path you should take.

» MORE: Should I file for bankruptcy?

What is the difference between debt consolidation and credit card consolidation?

Both are similar and often used interchangeably when talking about minimizing your debt. Debt consolidation can include multiple sources of debt combined into a new unsecured loan. Credit card consolidation is only your credit cards being consolidated.

Will debt consolidation hurt my credit score?

At first, taking out a new loan will decrease your credit score. However, your score should bounce back quickly as long as you are making on-time payments on your new loan. Decreasing credit card balances lowers your credit utilization rate, which accounts for up to 30% of your score.

Is debt consolidation worth it?

For many in debt, consolidation simplifies repaying creditors. Taking out a debt consolidation loan isn’t enough, though. You need to also budget and stop taking on new debt if you want your efforts to feel worthwhile.

Bottom line

Debt consolidation can be a smart financial move if you want to tackle many debts at once. However, consolidation isn’t a cure-all. You will still need to budget, make on-time payments and eliminate how much new debt you take on. The first step is to compare personal loan companies to discover which consolidation options are best for you.

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