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Updated on Tuesday, April 28, 2020
Debt consolidation is the process of rolling several debts into one easy-to-manage payment. It’s a strategy you can use to simplify the debt payoff process and save some money on interest. If you’re overwhelmed with multiple high interest debts, it may be just what you need to become debt-free faster.
What is debt consolidation and how does it work?
If you have many unsecured debts to pay off, you can turn them into a single monthly payment through debt consolidation. When you consolidate your debt, you won’t have to manage different payments, interest rates, payment dates and payback periods. You’ll eliminate confusion and make the process of repaying debt more manageable.
While there are several debt consolidation strategies at your disposal, a debt consolidation loan is a popular option. A debt consolidation loan is a personal loan you use to combine multiple debts with a new one, ideally with a lower interest rate and more favorable terms. You’ll receive a lump sum of cash to pay off your debts, and then make a single monthly payment on your new loan. (Some lenders can pay off your creditors directly, however.)
You can use debt consolidation to pay off consumer debt such as:
- Credit cards
- Medical bills
- Utility bills
- Payday loans
- Collection bills
Once you figure out all the unsecured debt you owe, use our debt consolidation loan calculator to get an idea of how long it will take you to repay them. The calculator compares the cost of all your debts versus the cost for a debt consolidation loan. It can help you determine how much money you can potentially save.
Pros and cons of debt consolidation
Where to find debt consolidation loans
Banks, credit unions and online lenders all offer debt consolidation loans. You might start your search for a loan with your current bank or by looking up lenders in your area who offer debt consolidation loans. But don’t overlook online lenders. They have lower overhead costs compared to lenders with brick-and-mortar locations and can pass those savings on to borrowers.
Loan marketplaces such as LendingTree can be especially helpful when you’re exploring lenders. By filling out a simple form, you can be matched with up to five lenders. You might also check out MagnifyMoney’s personal loan marketplace. Here are a few options you’ll find there.
24 to 60 months
36 or 60 months
24 to 84 months
$7,500 to $40,000
$4,000 to $25,000
$5,000 to $100,000
1.99% - 4.99%
1.00% - 5.00%
No origination fee
Minimum credit score requirement
How to compare debt consolidation lenders
To understand your loan options, you’ll want to prequalify with several lenders. This process only requires you to provide basic information about yourself, your finances and the loan you want. Prequalifying will give you an idea of the kinds of loan terms you may get when you formally apply.
As you review lenders and offers, pay attention to such factors as:
- Interest rates
- Borrowing limits
- Repayment terms
- Fee structures
- Minimum credit score requirements
Is debt consolidation worth it?
Debt consolidation may be a good idea if…
- You have good credit: Lenders reserve their best loan terms, such as low interest rates, to borrowers with strong credit profiles. A lower rate could translate to a lower overall cost of borrowing.
- Consolidating would make repayment cheaper: Debt consolidation is generally used to make repayment cheaper. That means accessing a loan with fewer fees and a lower interest rate. However, you might also choose a shorter-term loan to minimize interest charges.
- You have other bills to worry about first: Debt consolidation may also make sense if you want lower monthly payments, such as by picking a longer-term loan. Although this would increase your total borrowing costs, it could allow you to focus on other financial priorities by freeing up some cash each month.
- You’re tired of juggling multiple loans: If you have several credit card and loan bills to worry about, debt consolidation could make your life easier. By combining your debts, you’ll only have one monthly payment to worry about.
Debt consolidation may be a bad idea if…
- You have bad credit: Borrowers with poor credit may find it difficult to find an affordable loan to consolidate debt. However, if you’re facing super-high interest rates, such as those offered on payday loans, a debt consolidation loan may yet be more affordable.
- You’ll only rack up more debt: Debt consolidation can be a great way to wipe out credit card debt. But if freeing up your credit lines only means you’ll rack up more credit card debt, then consolidation may not make sense. You don’t want to bury yourself deeper into debt.
- It wouldn’t save you money: Lenders commonly charge an origination fee equal to 1% to 8% of your loan amount. Tack on potential prepayment penalties from your old creditors, and you may find debt consolidation won’t save you money after all. Take these factors into account when exploring your options.
3 debt consolidation alternatives
Balance transfer credit card
A common alternative to a debt consolidation loan is a balance transfer. With this repayment strategy, you’ll take out a balance transfer card and move your existing credit card debt onto it. The benefit of a balance transfer card is that they commonly come with a promotional 0% APR. You can avoid interest charges by repaying your debt in full during the promotional period.
However, if you don’t repay your debt in full, you’ll be responsible for all of the interest that accrued. There’s also a balance transfer fee you’ll typically pay; it’ll be a percentage of the balance you transfer. That said, this strategy is one of the best for consumers who can aggressively repay what they owe and are sure the balance transfer fees they’ll pay will be offset by the amount they save on interest.
Home equity loan
A home equity loan allows you to borrow against the equity you have in your home. Other factors such as your outstanding mortgage balance, home’s value and your credit health will affect your loan eligibility and amount.
Because you use your home as collateral, you’ll find home equity loans come with better terms than you may find on an unsecured loan such as a personal loan. However, you’ll find a longer application process as well as closing costs. You should be able to reliably make payments in full and on time each month, too. Otherwise, you risk losing your property.
With a 401(k) loan, you borrow money from your retirement savings and repay them over time with interest. Your monthly payments, including interest, go right back into your retirement account. Unlike with a 401(k) withdrawal, where you permanently remove money from savings, you won’t have to pay taxes or penalties on a 401(k) loan unless you default.
You can access this type of loan through the retirement plan offered by your employer. Often, you’ll have up to five years to repay the loan amount. If you leave or lose your job, though, you’ll be required to repay the full loan amount within a short period.
Debt settlement involves negotiating with your creditors to settle for less than what you owe. You can hire a debt settlement company to negotiate with creditors on your behalf, though that may be a risky move. That’s because some debt settlement companies will ask you to stop making payments in order to starve creditors into negotiating over a payoff amount; you’re also liable to pay fees.
Bankruptcy is a legal process where your assets are used to pay off debts (Chapter 7) or you repay debt via a debt repayment plan (Chapter 13). Since bankruptcy comes with long-term legal and financial consequences, it’s wise to consult a bankruptcy lawyer before pursuing it.
Debt consolidation can be a great way for you to take control of your debt and improve your finances. However, it is not right for everyone so it’s important to do your research before you take the plunge.