What Is Debt Consolidation?

Debt consolidation involves rolling multiple debts into one through a single, bigger loan. This simplifies your payments, leaving you with only one monthly due date and one interest rate to think about.

Consolidating your debt can also open better opportunities. Lenders may offer you lower interest rates or better terms, which can help if you have multiple high-interest debts. However, debt consolidation may not fit all situations. For instance, if your credit score is not high enough to access competitive rates, you may end up paying more interest over the life of the loan.

To fully reap the benefits of a debt consolidation loan, it helps to understand your options, how they work and the overall pros and cons of consolidating.

Debt consolidation can work wonders for your debt repayment strategy. It combines multiple debts into one loan, reducing the number of monthly payments and interest rates you have to keep track of.

Consolidation works with a variety of debt, be it unsecured debt (like credit card balances or student loans) or secured debt (like auto loans or mortgages).

Lenders will require a credit threshold and income to approve you for a debt consolidation loan. This can vary from lender to lender, but you will typically need a FICO score of at least 670. If you qualify, you can get a debt consolidation loan from your bank or credit union.

However, if you do not meet the requirements, you may opt for a debt management program instead. This does not factor in your credit score or require you to get a loan. Instead, debt management involves getting the help of professionals to plan and budget your income.

There are various ways you can consolidate debt through loans or management plans. If you plan to get a loan, there are two major categories: secured and unsecured. Secured loans require collateral and often come with lower interest rates due to the security of the provided asset. Unsecured loans do not require collateral and may have higher interest rates.

Debt Consolidation Loan

A debt consolidation loan is a personal loan meant to consolidate debt. Like most personal loans, it is typically unsecured, which means your annual percentage rate (APR) will be based on your creditworthiness, income and the amount you want to borrow.

Lenders may require a FICO score of at least 670 for you to qualify for a debt consolidation loan. They may also require income verification and a certain income threshold. A debt consolidation loan is the most common method to roll multiple debts into one.

However, not all offers may be beneficial for you, which is why it’s important to compare loan terms and interest rates to find the best debt consolidation loans. For instance, a lender may offer you a low interest rate but a long term length, so you may end up paying more in interest. Additionally, you may not qualify for competitive rates if your credit score is low.

Debt Management Plan

A debt management plan is not a loan but rather a type of plan or program you can undertake yourself or with professional assistance. It involves financial planning and budgeting to eliminate debt.

While you can create a debt management plan yourself, it may be wise to get the advice of a financial advisor or planner. You can also opt for credit counseling to get advice on credit, money management and debt management. This option may be viable if your credit is not good enough for other debt consolidation avenues.

Personal Loan

Personal loans can be used for almost any need, including debt consolidation. While most debt consolidation loans are a type of personal loan, the difference lies in the purpose. A personal loan may be a better option if you would like to borrow money to consolidate debt and pay off other bills.

However, keep in mind that interest rates and repayment terms will depend on your creditworthiness and income. If your credit is not ideal, you may end up with loan offers with higher interest rates.

Balance Transfer Credit Cards

A balance transfer credit card is a consolidation method for credit card debt. It involves transferring credit card debt from multiple cards into one, up to the limit of your new card. This strategy is often advantageous as many credit card providers offer balance transfer cards with a 0% APR for the first six to 20 months.

A transfer fee is often charged for balance transfer transactions, but if the lender offers a 0% APR for a certain period, it can compensate for the added cost.

If you opt for a balance transfer card, the balance transfer process may take anywhere from seven to 21 days to have your balance transferred completely. Then, your new card issuer will pay off the debt to your old card or give you a check to let you pay it off yourself.

Home Equity Loan

A home equity loan is a type of secured loan where you use your home’s equity, or the difference between your home’s market value and the balance of your mortgage, as collateral. With a home equity loan, you get a lump sum and a fixed repayment plan, interest rates and monthly payments, so your payments will be consistent for the life of the loan.

Home equity loans can be used for any purpose, including debt consolidation. They’re a low-cost alternative compared to credit cards, as they often have lower interest rates in part due to the asset that backs your loan. However, a home equity loan can put your home at risk of foreclosure, and the bank can take your home if you fail to pay off the loan.

Home Equity Line of Credit (HELOC)

A home equity line of credit (HELOC) is similar to a home equity loan, using the equity gained on your home as collateral. However, unlike a home equity loan, a HELOC is not a lump sum but a line of credit. You can take what you need up to the limit granted by the lender.

A HELOC may be better than other debt consolidation methods as it allows you to only borrow what you need to cover certain debts even if you are approved for a higher limit. You are also likely to have a lower interest rate and initial costs, given how it’s secured using your home. However, similar to a home equity loan, a HELOC puts your home at risk of foreclosure if you are unable to repay your loan.

Student Loan Programs

Individuals with multiple student loans can also consolidate their debt through student loan consolidation programs. However, options can vary based on whether a borrower wants to consolidate federal or private student loans.

The federal government offers Direct Consolidation Loans for federal student loans, which allows you to combine multiple federal loans into one. This can also grant you access to income-driven repayment plans and turn variable-rate loans into fixed-rate ones. However, any outstanding interest from your previous loans will become part of your principal.

Private student loan lenders also offer refinancing avenues, which may let you consolidate federal and private loans together. This can be advantageous if you have debt with private and federal lenders, but note that your interest rate will likely be higher than with a Direct Consolidation loan.

Whether debt consolidation is a good idea will depend on your situation. Not all borrowers qualify for a debt consolidation loan, while some may pay more. Explore the pros and cons of consolidating debt to help you decide if it’s the right option for your needs.

Consolidating your debt is a big financial move, as it entails taking out a huge loan to cover multiple debts. However, everyone’s circumstances are different, which is why it’s important to evaluate yours to see if consolidating your debt is best for your personal needs. Explore the circumstances that indicate when debt consolidation is the right step to take.

• If you have multiple monthly debts. If you are paying for more than two or three debts a month, you may want to consider consolidating your loan. This way, you reduce the likelihood of missing out on a payment.
• If your debts have high interest rates. High interest rates can make it hard to eliminate debt, especially if multiple debts carry high rates. By consolidating debt, you have a chance to reduce how much you’re paying in interest.
• If you have a better credit score than before. If your credit score has improved over time from on-time payments of your current debts, then your chances of receiving more competitive rates increases if you get a debt consolidation loan. This means less interest and better terms, which can help you get rid of debt faster.

Debt consolidation can be a confusing topic for those who haven’t delved into it before. Review a few commonly asked questions about it below.