How to Consolidate Debt – Your Essential Guide
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As confusing as the current economic headlines may be, it is a fantastic time to get our financial house in order. One of the ways we can do this is by creating a solid plan to tackle debt and eliminate the burden of debt from our personal finances once and for all. If you’ve ever wondered how to consolidate debt and if it’s the right strategy for your own budget to become debt-free, then keep reading.
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What is debt consolidation?
Debt consolidation means combining several debts into a single loan term and one monthly payment, ideally with a lower interest rate than you currently pay. You can use debt consolidation for various high-interest debts, including credit cards, medical bills, and unsecured loans.
You can also consolidate student loans, which typically involves a separate process. You must also follow strict parameters with federal student loans, especially if you pursue federal student loan forgiveness. Debt consolidation is also slightly different from a loan refinance, where refinancing means changing the loan terms on an existing, single loan.
If done correctly, debt consolidation gives you a lower interest rate and the simplicity of dealing with only one monthly payment versus several. In some cases, you could save hundreds or even thousands of dollars in interest over time from combining multiple debts into one.
Related: Inheriting Debt: Next Steps To Take
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How do you consolidate debt?
There are a few consolidation options. One method may be a better choice for your finances, but it’s important to understand how each works and its impact.
Use a balance transfer credit card
This consolidation method uses a balance transfer credit card with a 0% balance transfer APR. You’ve likely seen the offers advertised where some cards offer anywhere from six months to 21 months for 0% APR on balance transfers if approved.
This method allows you to take your higher interest rate credit card debt and transfer it to this new card. Your new interest rate will be 0% for the advertised period, and you could avoid making costly interest payments as long as you make on-time payments.
This method is ideal for those with credit card debt with higher interest rates. However, there are cases where it may be possible to pay off personal loan debt too. Some credit card companies, such as Discover, will include balance transfer checks that you can use for personal loans or other debts. If you’re interested in pursuing this, you should confirm this option is available before applying for the credit card.
This is an easy, straightforward way to save on credit card interest charges, but is it right for everyone? Consider the following before you choose a balance transfer credit card:
- The balance transfer fees typically range from three to five percent. When you crunch the numbers, you will need to factor this into your payoff calculation.
- You will lose your promotional APR if you don’t make minimum payments on time, so if payment dates are a concern, think twice.
- Taking on another credit card involves a credit check and your payment history (and application) will be reported on your credit report. Consider the impact on your credit score before pursuing it.
- Your credit limit may be insufficient to pay off your higher interest rate cards.
- You may not be approved if you have a bad credit score.
Related: Best Balance Transfer Cards
Debt consolidation loan
Another option for consolidating your debt is to take out a debt consolidation loan. This type of loan can be used to pay off various debts. Again, the loan will have a lower interest rate than your current debts, which could help you pay off what you owe even sooner and save money on interest.
These personal loans come with a fixed monthly payment, making it ideal for budgeting and simple financial management. Like a balance transfer credit card, this loan requires a credit check based on your credit history and score, so it’s typically better suited for someone with a good to excellent credit score. You can also shop around for personal loans to ensure you find one offering the lowest interest rate and repayment terms.
Home equity loan or line of credit
If you own a home and have built up equity, you have two more options for consideration.
A home equity loan line of credit (HELOC) is where you borrow against the equity you’ve built up in your home but only pay interest on the amount you borrow. You can use the funds for anything, including debt payments, like a personal loan.
Like a HELOC, a home equity loan (HELOAN) lets you borrow against the equity, but instead, you take out a specific amount with a fixed interest rate. You have a fixed monthly payment.
Both options let you use the funds for almost anything, including debt payments. The interest rates for these products are typically low and competitive too, making them appealing. And with today’s increased home values, you may be able to borrow a significant amount.
There are drawbacks, though. Consider the following before using your home’s equity:
- Higher costs. Each has fees, including an origination fee, interest, and closing costs.
- Your home is on the line. If you fail to make on-time payments, the bank could foreclose on your home since it’s the loan's collateral.
- The value could drop. If your home value drops, you could end up underwater and owe more than your home is worth.
Debt management plans
You will often see debt management plans, or DMPs, offered by credit counseling companies. They help people restructure their unsecured debts, such as credit cards and personal loan debts.
Before signing with a DMP, you should talk to the credit counselor about your financial situation and how the plan could help. The counselors will call the creditors from your current debts and attempt to negotiate lower interest rates and fees. Meanwhile, you make payments (for the full amount) to the credit agency, and they will make the payments on your behalf.
Going this route means closing all your credit cards and avoiding applying for any new credit, and you’re subject to the fees charged by the DMP.
Debt settlement
With this debt relief plan, you hire a debt settlement company to negotiate lower amounts to settle your debts. It’s a highly risky move because you stop paying your creditors during this time on the chance the settlement company can help lower your debts. If a settlement is reached, it could be reported to the IRS as income, and you will be responsible for paying the taxes.
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- Subject to qualification and approval. $1,500 monthly income required.
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How debt consolidation impacts a credit score
Your debt consolidation route may impact your credit score in different ways. Be sure to consider how the choice you make impacts your:
- Credit utilization: How much credit you use versus your extended amount. Healthy credit utilization is less than 30%, according to Experian, meaning you only use 30% of the credit extended to you.
- Debt-to-income ratio (DTI): Lenders want to see the total amount you owe monthly versus the total amount you earn, around 36% or less. Although your income is not reported on your credit report, lenders take your income and your credit information and calculate the amount of debt you’re obligated to pay each month.
Who should consider a debt consolidation plan
You may be a good fit for debt consolidation if:
- You have good credit, and you can apply for new credit without too much impacting your score.
- You have current debts with high interest rates.
- You feel overwhelmed financially and need a structured repayment plan.
When debt consolidation may not be the right choice
On the other hand, you should look for alternatives to debt consolidation if:
- Your current debt is small.
- Your types of debts include federal student loans or other secured loans, like mortgages and auto loans.
- You fear you won’t be able to change your spending habits, keep up with the new loan payments, or adopt new positive financial habits.
Related: How to Pay Off $10,000 in Debt
Debt Consolidation Calculator
Alternatives to debt consolidation
If your debt is small or you have the desire to tackle your debt without the consolidation process, consider a debt payoff strategy, such as:
- Debt snowball method: You first pay off the debt with the smallest loan amount with as large of a monthly payment as possible while only making minimum payments on all other debts. Then you apply that payment to the next-to-smallest debt amount once it’s paid off. You keep going until you’ve wiped out all debt.
- Debt avalanche method: With this strategy, you first pay off the debt with the highest interest rate, with minimum payments on all others. Once it’s wiped out, you apply the payment to the second-highest debt and keep this strategy in place until the debt is gone.
You could also create a new budget that includes less spending in discretionary categories and using the “leftover” amount towards your debt. You could consider several budgeting methods, and it’s not a one-size-fits-all approach either.
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- TurboDebt has a Trustpilot rating of 5/5 based on 1288 reviews
- Subject to qualification and approval. $1,500 monthly income required.
- Apply in 5 minutes. If you qualify, chat online with a friendly online debt representative.
The bottom line
Debt consolidation could be the right strategy if you are struggling to keep up with multiple loan payments, and a singular payment would add simplicity to your life. It’s also ideal if you are ready to commit to tackling debt and altering your spending habits. There are multiple approaches to debt management, and it’s essential to weigh the pros and cons of each of these strategies before pursuing them.
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Writer
Sara Coleman is a former corporate gal turned creative entrepreneur. She began writing professionally several years ago and now contributes to multiple websites, blogs, and magazines. She’s also an avid reader and can’t resist a great historical fiction novel. Sara holds a BA in journalism from the University of Georgia and can be found supporting her Bulldogs every chance she has. She resides in Charlotte, North Carolina, with her wonderfully supportive husband and three children. When she’s not ushering her kids to sports and dance lessons, she can be found creating content for her own website, TheProperPen.com.
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