What is debt consolidation and should I consolidate?

Merging multiple debts into one may help if you’re overwhelmed

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Trying to manage multiple debt payments from credit cards, student loans or personal loans can feel overwhelming. With different payment dates, interest rates and loan terms, it’s easy to get mixed up.

Consolidating your debt can help to streamline the debt repayment process and potentially lower the cost of your debt. Here’s what it is, the different methods you can use and how to determine if consolidation is the right choice for you.

Key insights

  • Debt consolidation involves rolling several separate debt payments into one regular payment.
  • There are different methods you can use to consolidate debt, including a balance transfer credit card, a debt consolidation loan and a home equity line of credit (HELOC).
  • When selecting a debt consolidation method, consider fees, interest rates and other terms.

How does debt consolidation work?

Debt consolidation involves merging several separate debts into one payment plan. Consolidating your debt can simplify the debt management process, and if you can secure a lower interest rate, it can lower your overall debt payments.

However, Jay Zigmont, P.hD., a certified financial planner and the founder of Childfree Wealth, cautions that if you do consolidate your debt, “lock and cut up your credit cards so that you can’t take out more debt. Too many people fill their credit cards back up after debt consolidation.”

Zigmont says the key to understanding debt consolidation is to recognize that “it just moves your debt, it does not pay it off.”

Types of debt consolidation

There are a variety of methods you can use for debt consolidation, including the following:

Balance transfer credit card
With a balance transfer credit card , you move multiple debts onto a card with a low or 0% introductory interest rate. The goal is to pay down your debt as fast as possible to take advantage of the intro rate. If you can manage this, you can save a significant amount by not paying interest.

Promotional rates typically last for a period of six to 18 months, at which point the interest rate goes up to a regular rate. You want to find a card that offers a 0% intro rate for as long as possible.

Before selecting a card, determine if there are any fees, such as a transfer fee or an annual fee. Transfer fees typically range between 3% to 5% of the total balance transfer. If there are fees, it’s worth performing a quick calculation to see if the savings outweigh the costs.

To get a 0% balance transfer credit card, you will typically need a good to excellent credit score .

Debt consolidation loan
A debt consolidation loan is a type of unsecured personal loan offered by most banks and credit unions. Many debt consolidation loans offer lower rates than a typical credit card. However, in some cases, the lower rate is only available for a certain period of time, similar to a balance transfer credit card. Then the rate goes up and you have to pay more.

If you’re considering a debt consolidation loan, make sure you compare rates and terms on different loans to assess how much interest and fees you’ll have to pay overall. In some cases, you might get an offer for a lower monthly payment, but this is because your payment terms are stretched out over a longer time, which means you might end up paying more overall.

Similar to a balance transfer credit card, you will typically need a good to excellent credit score to secure the best rates.

Home equity line of credit
A home equity line of credit (HELOC) allows you to borrow money against the equity you’ve built in your home. You can convert a percentage of the equity you’ve built and use it to consolidate debt.

The benefit of a HELOC is that it will likely provide a lower interest rate than any credit card or other high-interest debt, since it is a secured debt.

However, there is risk involved. That’s because when you move your credit card debt to a HELOC, you are putting your house at risk. “If you use a HELOC as a consolidation loan, you are literally mortgaging your house to pay for credit cards,” warned Zigmont.

So while a HELOC has the potential to save you money, you must be extremely disciplined with your debt payment.

» MORE: How to consolidate debt with mortgage refinance

401(k) loan
If your employer permits it, another option is to consolidate with a 401(k) loan. With a 401(k) loan, you can borrow money from your retirement account balance with the intention to pay the money back. You can generally borrow up to half of your account balance or $50,000, whichever is less.

Note that even though you are borrowing money from yourself, the loan still requires you to pay interest using after-tax dollars.

The benefit of a 401(k) loan is it generally offers a lower interest rate, usually a point or two above prime. Plus, there is no credit check. However, there are also risks. For instance, if you don’t repay the loan (including interest) within the specified amount of time (maximum of five years), the amount is considered income and will be taxed accordingly.

You might also have to pay an additional 10% on the amount if you aren’t at least 59½ years old or you qualify for another exemption. This also means you are reducing the amount of money you have saved for retirement.

Zigmont cautions against using a 401(k) for debt consolidation. He said, “While some people say that using a 401(k) is ‘borrowing from yourself,’ you are really stealing from your future.”

Pros and cons of debt consolidation

As with most financial decisions, there are pros and cons to debt consolidation. Here are some of the main ones to watch out for:


The pros of debt consolidation include:

  • Streamline your debt repayment: Consolidating your debt results in only one payment to worry about each month rather than trying to juggle different payment dates.
  • Faster debt repayment: If you take on a balance transfer credit card with a low or 0% introductory rate, you may be more motivated to pay it off during the promotional period.
  • Lower monthly payments: Depending on the type of debt consolidation method you use and the terms you can secure, you might end up with lower monthly payments.
  • Lower interest: With a good or excellent credit score, it’s possible to secure a debt consolidation method with a lower interest rate than you were paying on high-interest debts.


Some of the cons of debt consolidation are:

  • Drop in credit score: Depending on the type of debt consolidation method you use, you might need to go through a hard credit check. A hard inquiry will generally cause a temporary dip in your credit score.
  • Interest rate increase: In some cases, you risk an increase in interest rate. For example, if you don’t pay off a 0% balance transfer credit card before the promotional period is up and end up paying high credit card interest.
  • Paying more over the long term: There's a chance you might end up paying more over the long run if you stretch out your payments.
  • Fees: Some balance transfer methods may involve fees, including annual fees, balance transfer fees or penalty fees.
  • Risk: Different consolidation methods come with varying levels of risk. For instance, if you miss a HELOC payment, you risk losing your home.

Should I consolidate my debt?

If you’re debating whether it’s a good idea to consolidate your debt, consider the following factors:

  • Your credit score: If you want to secure the best rate and terms, you need to have a good to excellent credit score.
  • Interest rate: Are you able to secure a lower interest rate?
  • Fees: After accounting for annual fees or transfer fees, is it still worth it to consolidate?
  • Debt repayment plan: Do you have a solid debt repayment plan in place? While the act of consolidation can simplify the debt repayment process, it won’t solve your debt problems. If you don’t have a plan, it’s easy to fall back into the same habits.

» MORE: How to manage your money

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    Does debt consolidation impact your credit score?

    Yes, consolidating your debt can impact your credit score. If a hard credit inquiry is required to take on a new credit card or loan, this can cause a temporary decline in your score. However, if consolidating your debt helps you stick to a repayment plan, it can increase your score in the long run.

    Is debt consolidation free?

    The cost of debt consolidation will depend on the method you use. Consolidating your debt can involve different fees, including balance transfer fees, annual fees, origination fees or closing cost fees.

    Is debt consolidation the same as debt settlement?

    No, debt consolidation is when you merge multiple debts and pay them off using one large loan or credit card. Debt settlement is when you hire a company to negotiate your debt with your creditors.

    Can debt consolidation stop wage garnishment?

    The act of consolidating your debt won’t stop wage garnishment. However, if consolidating your debt allows you to pay off the lender that is garnishing your wages, then the garnishment will stop.

    Are debt consolidation loans taxable?

    Debt consolidation loans are not taxable. Since you are not earning money on a debt consolidation loan, there is no additional income to tax.

    Bottom line

    Debt consolidation is when you roll multiple debts, such as credit cards, student loans, or personal loans, into a single monthly payment. There are several debt consolidation methods, including a balance transfer credit card, debt consolidation loans, a HELOC and a 401(k) loan. Before deciding which is right for you, compare the benefits and risks associated with each.

    Debt consolidation can simplify the overall debt repayment process and has the potential to result in cost savings. However, it’s important you have a plan in place for how you intend to repay the money you consolidate and for how you will avoid taking on new debt.

    ConsumerAffairs writers primarily rely on government data, industry experts and original research from other reputable publications to inform their work. To learn more about the content on our site, visit our FAQ page. Specific sources for this article include:
    1. Consumer Financial Protection Bureau, “ What do I need to know about consolidating my credit card debt? ” Accessed March 19, 2023.
    2. IRS, “ Considering a loan from your 401(k) plan? ” Accessed March 19, 2023.
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