Debt Consolidation
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Is Debt Consolidation a Good Idea?

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You’ve racked up multiple forms of debt over the years, and now you’re ready to pay it off once and for all. Perhaps you’re wondering, is debt consolidation a good idea? Debt consolidation is a way to combine all your debt and pay it off more easily in one monthly bill. If you’re considering debt consolidation, read on to learn what to expect.

Debt consolidation: The basics

Debt consolidation is a method you can use to repay debt. Typically with debt consolidation, you will take out a new loan or line of credit and use it to pay off your existing debt. This allows you to combine multiple kinds of debt — such as credit cards, medical bills and personal loans — and repay it on a more manageable payment plan. Instead of juggling three or four payments (or more), you’ll have a single bill every month.

Common ways to consolidate debt include:

  • Debt consolidation loans: This is a personal loan that you use to pay off debt. Debt consolidation loans typically come with a fixed interest rate and a fixed loan term, and can be secured or unsecured. (A secured loan is backed by collateral like your car; an unsecured loan isn’t.)
  • Balance transfer credit cards: You may be able to move existing debt onto a balance transfer credit card, which typically offers a low- or no-interest promotional APR for a set period of time. As long as you pay off the balance before the promotion expires, your debt will stay relatively interest-free.
  • Other types of loans: It’s possible to consolidate your debt and pay it off with other types of loans, like 401(k) loans, home equity loans and home equity lines of credit (HELOCs). These loans are all backed by collateral, like your home or retirement savings.
  • Debt management plan: A nonprofit credit counselor can set up a straightforward debt repayment plan for you, while also teaching you about healthy financial habits. You may be asked to close credit card accounts, but if you’ve struggled with unmanageable debt for years, this type of program can provide the support you need.

Debt consolidation pros and cons

Pros Cons
Personal loan for debt consolidation
  • Fixed APR available with monthly payments
  • Could have lower APR than what you’re currently paying
  • APRs can be pretty high for those with fair or bad credit
  • Subject to fees, such as loan origination fee and prepayment penalty
  • Those with bad credit might not qualify at all
Balance transfer credit card
  • Some cards come with introductory 0% APR periods, which can last as long as 20 months
  • APR could be lower than what you’re paying on your credit cards now
  • Variable APR available
  • Can be used only for credit card consolidation
  • Introductory offers are reserved for borrowers with strong credit
  • May be subject to a balance transfer fee of 3% to 5%
Home equity loans
  • Fixed APR available with monthly payments
  • Interest rates are usually lower than with unsecured debt
  • You can consolidate a large amount at once
  • Only homeowners are eligible
  • There’s a risk of foreclosure if you fail to pay
  • You could end up underwater on your home, taking out more money than the home is worth
  • Home equity loans are subject to closing costs
401(k) loan
  • No credit check is needed
  • Interest rates are usually low
  • You’ll be borrowing from and paying interest to yourself rather than a lender or bank
  • Some servicers won’t allow 401(k) loans
  • Payments are made with after-tax dollars, so you’ll get taxed again during retirement
  • If you default on the loan, the amount is subject to income tax and a 10% penalty
  • If you lose your job, you may have to repay the loan in its entirety within a few months
Debt management plan
  • These comes with low or no cost
  • A credit counselor may be able to negotiate for lower fees and interest rates on your debts
  • Such plans can consolidate many types of debts into a single monthly payment
  • Debt management plans won’t hurt your credit score if you adhere to them
  • These can only be used for unsecured debts
  • You’ll likely have to stop using or close your credit cards
  • The plan can take up to five years to complete, during which time you can’t take out credit

Why debt consolidation can be a good idea

It makes repayment cheaper or easier to manage

Debt consolidation can either shorten or extend your repayment timeline, and both possibilities may help you in the end.

Let’s take debt consolidation loans, for example, which typically come with 12- to 60-month terms or longer.

  • A short-term loan could make debt repayment faster and cheaper. You might be able to repay your overall debt considerably faster than you could with your existing repayment options, especially if you also qualify for a lower interest rate. Your monthly payments may be higher, however.
  • A long-term loan could extend how long you are in debt but lower your overall monthly costs. This is the major benefit to a longer term, though you’re likely to pay more in interest over time.

It doesn’t come with excessive fees

With any debt consolidation method, make sure potential fees don’t vanquish whatever savings you might generate. Personal loans, for example, can come with an origination fee that typically ranges from 1% to 8% of the total loan amount. If your loan is $5,000, this means you could spend as much as $400 on this one fee alone.

  • Balance transfer credit cards typically offer a 0% intro rate to borrowers for a set period of time. If this isn’t available, credit card companies usually have a balance transfer fee between 3% and 5% of the transferred amount. So even though you might benefit from a low or no promotional APR, the balance transfer fee can increase your debt load. With a 0% APR introductory offer, you’ll be able to tackle your debt interest free for a limited period of time. If you don’t repay your entire balance before the promotional period ends, you could be stuck paying interest on your remaining balance.
  • Credit counseling agencies can come with a startup fee, as well as a monthly fee between $25 and $50. However, these agencies sometimes reduce or waive fees for debt management plans, especially if a borrower is struggling financially.

Why debt consolidation can be a bad idea

The APR rates could be higher than your current ones

Before signing the dotted line for a debt consolidation loan, be sure to check what the APR rates are for your current lenders. If you apply for a debt consolidation loan and the APR rates are similar, if not higher, a debt consolidation loan may not make much of a difference to your day-to-day finances.

You can achieve better APR rates by improving your credit score. For reference, the average credit score in the U.S. is 711 for FICO and 698 for VantageScore. If your credit score falls under these averages, the average APR rate you can expect for a debt consolidation loan is 21.37% (as of May 25, 2021).

You may still be unable to afford the loan payments

Perhaps you’re overwhelmed by your debt because, unfortunately, you’re just too buried. If your debt exceeds more than half your income, you may want to consider debt-relief options, including debt settlement or even bankruptcy if paying back your debts becomes out of the question. Here’s how these two options break down.

  • Debt settlement: By approaching your loans via the debt settlement method, you may be able to negotiate a settlement with your lenders to settle your debts. Debt settlement programs are managed by companies that will contact your lender on your behalf and pay a lump sum both parties agree to. You will then make payments to your debt settlement company rather than your previous lender. Keep in mind that debt settlement may negatively impact your credit score for up to seven years and that not all lenders agree to debt settlements.
  • Bankruptcy: If you’re drowning in debt, behind on payments, at risk of losing your home or vehicle and have no light at the end of the tunnel, then filing for bankruptcy might be the right choice for you. In 2020, there were 522,808 non-business bankruptcy filings. Keep in mind that filing for bankruptcy can severely impact your credit profile for a long time, and may prevent you from accessing credit options down the road. Chapter 7 bankruptcy can take ten years to come off your credit history and Chapter 13 can take seven years. If you believe bankruptcy is the right option for you, read the graph below to learn about the different types of bankruptcy for individuals.
Which type of bankruptcy is best for me?
Type of Bankruptcy Filing Best If … Avoid If …
Chapter 7 You’re in major financial distress and are seeking a fresh start.

You don’t have the ability to repay your debts within 36 to 60 months.

You have enough income to repay your debts over a 36- to 60-month period and you have assets, such as a home or a car, that you would like to keep.
Chapter 13 You have an income sufficient enough to steadily repay your debts.

You have assets, such as a home or car, that you very much want to retain.

Your financial situation is in bad shape, and you don’t have many assets worth keeping.

You don’t expect to be able to stick to a repayment plan.

Using a debt consolidation calculator

A debt consolidation loan can help lower your repayments if you’re able to secure a lower APR rate and good loan terms. To find out whether debt consolidation is right for you, use our free debt consolidation calculator tool. All you need to do is provide the amount of debt you owe, your credit score, whether you rent or own your home and which state you live in. Once you provide that information, we will offer you your savings breakdown and what the best options might be for you.

How to find a debt consolidation loan

  • Determine what you want in a loan: The first step is to pin down your financial goals. Do you want a manageable monthly payment? The lowest interest rate or fees possible? Depending on your income and credit history, this type of loan can come with a lower interest rate than what you might pay for debt like a credit card. For that reason, it might help you to consolidate multiple debts that carry high interest rates.
  • Research lenders: It’s possible to find debt consolidation loans at brick-and-mortar banks and credit unions, as well as with online lenders like LightStream and Upstart. Visit our personal loan marketplace to explore lenders and compare offers.
  • Prequalify: Try to prequalify with at least three lenders to see what kinds of loan terms might be open to you. You’ll need to provide basic information about your income, employment status and any other debts you have. To check your credit history, your lender will do a soft credit check, which won’t affect your score.
  • Compare loan offers: Once you’ve prequalified, compare interest rates, repayment terms, credit score requirements and fees for each prospective loan. Pay special attention to rates — they typically range from 5% to more than 30% for those with poor credit.
  • Formally apply: After you’ve identified the loan that’s right for you, send in a formal application. Your lender will ask for more detailed personal and financial information, as well as documents to prove your income, assets and debts. You can also expect a hard credit check, which may cause a temporary drop in your credit score.
  • Wait for a loan decision: Banks and credit unions take anywhere from a couple of days to a couple of weeks to approve personal loans. Most online lenders, however, offer decisions in as little as one or two business days.
  • If approved, wait for loan disbursement and pay off your debt: In most cases, lenders will deposit funds from a personal loan into a bank account electronically. This is the time to work your new debt repayment plan into a monthly budget to ensure you never miss a payment and don’t rack up late fees.

How to consolidate debt without taking out a loan

Debt consolidation loans aren’t the only way to consolidate what you owe to your lenders. Here are several other methods you can consider to work on your debt.

How to consolidate debt with a balance transfer credit card

  • Try to determine whether a quick payoff is realistic: To make good use of a balance transfer credit card, you’ll need to pay off your card balance by the time the promotional period ends (usually within 18 months). If you can’t make that goal, you’ll pay interest on your remaining balance at your new card’s APR for balance transfers.
  • Research balance transfer credit cards: Compare several cards to make sure they offer you the debt-shaving terms you need. For example, cards usually set a maximum for how much card debt can be transferred, so a balance transfer card with a $5,000 credit limit might not work if your card debt is $10,000. You can compare balance transfer options here.
  • Apply for the card with the best terms for your situation: Identify the card that has the lowest APR, longest introductory time frame or lowest balance transfer fee — whichever quality you deem to be most important. Keep in mind that borrowers with the best credit scores qualify for the best terms.
  • Transfer your balance: Once you’ve been approved, transfer your current card balances onto your new card and work on paying off the debt quickly. A balance transfer credit card usually works best for borrowers who have a smaller amount of debt that they anticipate paying off in about a year.

How to consolidate debt with a debt management plan

  • Find an agency: Locate a nonprofit credit counseling agency in your area through the online database offered by the National Foundation for Credit Counseling (NFCC). Most likely, you’ll be speaking with your counselor by phone, but some agencies may also let you do it online.
  • Get your financial information in order: Before speaking with your counselor for the first time, pull together key financial information. This should include a list of current expenses (like what you pay regularly for housing, utilities and debts), as well as pay stubs and credit card statements.
  • Be prepared to close open accounts: If you sign up for a debt management plan, be prepared to close open credit accounts while you’re enrolled. This means you’ll see a drop in the total amount of credit available to you, so you may see a temporary dip in your credit score. While on a plan, you’ll make a monthly payment to your credit counselor, who will then distribute the amount to your creditors on your behalf. They will also negotiate with creditors to potentially have interest rates and fees reduced.
  • Stick to the plan: Most debt management plans take between three and five years to complete. Make sure you’re fully on board, or else your finances could suffer even more.

Debt consolidation with bad credit

The best interest rates typically go to borrowers with stellar credit. For borrowers whose credit score is excellent (760 or more), the average best APR offer was about 8.83%, according to June 2021 LendingTree data (the most recent available). For fair credit scores (640 to 679), it was more than doubled, at around 22.74%. With an extremely low credit score, you might not even qualify for a loan at all.

If you have poor credit that needs work, you might want to explore other debt consolidation options. For example, if you have significant equity in your home, a home equity loan may be able to provide you a lump sum of money, but at a generally lower interest rate, and with a longer loan term (five to 30 years, generally). And if you have significant retirement savings, a loan against your 401(k) or home equity could be your most affordable options.

However, these options can come with some drawbacks. With a 401(k) loan, you’ll sacrifice future earnings. With a home equity loan, your home is used as collateral, meaning you risk losing your property if you fall behind on payments.

Final thoughts: Don’t give up on your debt

The question of “is debt consolidation a good idea” depends on a variety of factors. No single approach will work for everyone, and the best solution for you will depend on the scope of your debt, your financial history and also your priorities.

But even if debt consolidation might be a good fit for you, it isn’t a magic spell that’ll solve all your money problems. You may need to pick up a second job or follow a budget in order to improve your financial situation. This can take time — but once you are able to cut down on and get your debt to a manageable point, you may reap the rewards of an improved credit profile and perhaps even shed some of your financial stress.


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