The pros and cons of debt consolidation

Debt is a worry for many people. At least 8 in 10 Americans have some form of consumer debt. It can be difficult juggling multiple payments each month. 

In some cases, consolidating your debt may be a reasonable option. Debt consolidation involves taking out a new loan to pay off existing debts. This allows you to combine all your debt payments into one monthly payment with one interest rate. 

Understanding how debt consolidation works as well as some of the key benefits and drawbacks can help you determine if this is the right solution for you. 

How debt consolidation works

Debt consolidation doesn’t erase your debt or reduce the amount you owe. Rather, it’s a way to simplify your debt and payment plan in order to help you get a better handle on debt repayment. Debt consolidation usually requires you to take out another, larger loan that combines all your other debt amounts so you will just have one lender. 

Sometimes, consolidating your debt can even lower your interest rate or reduce your monthly minimum payment, although there’s no guarantee. You can consider debt consolidation for credit cards, medical bills, past-due utility bills, payday loans, and other types of debt.

Types of debt consolidation

There are a few different types of ways to consolidate your debt. The first option is with a balance transfer credit card. This allows you to transfer your balance from an existing card to a new credit card that offers a 0% APR for several months. You can use the 0% APR promotional period to pay down your debt with no interest charges. Some cards do require a balance transfer fee, which is usually $5 or 3% to 5% of the transferred balance—whichever is greater.

You can also take out a personal loan through a bank, credit union, or online lender. In order to successfully consolidate your debt, you will need to get approved for a personal loan amount that is large enough to pay off your existing debt balances. Then, you will be left with only your new loan and a single monthly payment. 

Another way to consolidate your debt is through a home equity loan. This allows you to borrow against the equity in your home and works similar to a personal loan that you repay with fixed monthly payments. However, a home equity loan requires that you put your home up for collateral which means you could lose your home if you fail to repay the loan.

Debt consolidation pros and cons

Debt consolidation may be a good option for some, but it’s always important to consider the pros and cons and how they will impact your personal situation. 

Pros

• Simplified payments. Debt consolidation simplifies your payments so you no longer have to worry about several monthly payments during the month.
• Possible lower interest rate and reduced payment. Debt consolidation can lower your interest rate (you consolidate high-interest credit card balances by taking out a personal loan). 
• Chance to improve your credit. If consolidating your debt can help you start to make regular payments again or even pay off your debt faster, this can improve your credit. 

Cons

• Fees. A debt consolidation loan may have fees in the form of an origination fee for a personal loan, or a balance transfer fee for a balance transfer card. 
• Collateral with a home equity loan. Home equity loans are high risk since you put your home up for collateral, so make sure you can repay this type of loan on-time.
• May pay more over the life of your loan. Debt consolidation may also lengthen the repayment term, resulting in paying more interest over time.

When should you consolidate your debt?

It's important to consider your financial situation when deciding if debt consolidation is right for you. Debt consolidation may be a good option if you have multiple high-interest credit cards or loans, are struggling to make minimum payments, and have a solid repayment plan in place. 

Debt consolidation can also be helpful if you have a good credit score allowing you to qualify for a low-interest personal loan. However, if you have a low credit score or unstable income, debt consolidation may not be the best solution for you.

Frequently asked questions (FAQs)

Does consolidation hurt your credit?

Debt consolidation can result in a hard credit pull which could negatively impact your credit if you’ve had too many hard credit checks lately. However, the impact on your credit score is only temporary. Nevertheless, if you fail to repay your new loan or miss a payment, this can cause more damage to your credit score. 

Why is it so hard to consolidate debt?

Debt consolidation is not the best option for everyone. You will generally need good credit in order to take advantage of options like a balance transfer or personal loan. For a home equity loan, you need to be a homeowner and possess a certain level of equity in your property to qualify. 

How can I consolidate my debt without affecting my credit score?

Start by shopping around and comparing personal loan rates online by getting prequalified. Prequalifying should only take a few minutes and won’t impact your score as it’s a soft credit pull. This allows you to preview rates and terms and shop around. From there, you will need to fill out an application if you want to move forward with a loan. At that point, the lender will need to check your credit.