# What Is Debt Consolidation and When Is It a Good Idea?

Debt consolidation involves rolling multiple debts into one new loan or credit card to simplify your financial obligations and secure more favorable terms. By consolidating, you might reduce your interest rates or lower your monthly payments, easing the burden on your finances. This strategy can streamline your payment process, leaving you with fewer bills and due dates. Learn when debt consolidation is a smart move and how to navigate the process effectively.

### Key Takeaways

*   Debt Consolidation Simplified:\*\* Debt consolidation involves combining several loans into a new one, often to secure a lower interest rate or reduce monthly payments, which can simplify your financial management.
*   How It Works:\*\* This process can be done through methods like a personal loan, balance transfer to a new credit card, or a home equity loan, helping to pay off multiple debts efficiently.
*   Potential Drawbacks:\*\* While debt consolidation can reduce your interest burden, there are risks, such as a temporary dip in your credit score and the possibility of paying more in total interest if the repayment period is extended.
*   Types of Loans:\*\* Secured and unsecured loans are the primary types used for consolidation, with personal loans being a common option due to generally lower interest rates compared to credit cards.
*   Credit Score Impact:\*\* Initially, debt consolidation might lower your credit score slightly due to a credit inquiry, but it can help improve your score over time through reduced credit utilization and consistent payments.

![Debt Consolidation: Securing a new loan to pay off existing loans.](https://www.investopedia.com/thmb/XbQPAx53ucd8kJSDFT-WhX89hzk=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/debtconsolidation.asp-final-18e80676e0af4379a7962bfc4a0874de.png)

*— Investopedia / Julie Bang*

## Understanding Debt Consolidation Methods

You can roll old debt into new debt in several different ways, such as by taking out a new personal loan, a new credit card with a high enough [credit limit](https://www.investopedia.com/terms/c/credit_limit.asp), or a home equity loan. Then, you pay off your smaller loans with the new one.

If you are using a new credit card to consolidate other credit card debt, for example, you can transfer the balances on your old cards to your new one. Some even offer incentives, such as a 0% interest rate on your balance for a period of time. Some [balance transfer credit cards](https://www.investopedia.com/credit-cards/balance-transfer-credit-card/) offer deals like a 0% interest rate for a limited time. Debt consolidation can also simplify your finances by reducing the number of bills and due dates each month.

> **Fast Fact**
>
> Creditors often support debt consolidation to improve your chances of paying them back.

## Debt Consolidation: A Real-Life Example

Suppose you have three credit cards and owe a total of $20,000 on them, with a 22.99% average annual interest rate. You would need to pay about $1,048 a month for 24 months to bring the balances down to zero, and you'd pay about $4,601 in interest during that time.

If you consolidated those credit cards into a lower-interest card or loan at an 11% annual rate, you would need to pay about $933 a month for the same 24 months to erase the debt, and your interest charges would total about $2,157.

With a 0% credit card, your payments would be even lower, at least while the promotional period was in effect.  

## Evaluating the Risks of Debt Consolidation

Debt consolidation also has some [downsides](https://www.investopedia.com/pros-cons-debt-consolidation-8424036) to consider. For one, when you take out a new loan, your [credit score could suffer a minor hit](https://www.investopedia.com/debt-consolidation-hurt-credit-8426913), which could affect whether you qualify for other new loans.

Depending on how you consolidate your loans, you could also risk paying more in total interest. A new loan with lower payments but a longer term might cost more in interest over time.

> **Warning**
>
> You can also hire a debt consolidation company to assist you. However, they often charge hefty initial and monthly fees. It's often simpler and cheaper to consolidate debt yourself with a bank loan or low-interest credit card.

## Exploring Types of Debt Consolidation Loans

You can consolidate debt by using different types of loans or credit cards. Which will be best for you will depend on the terms and types of your current loans, as well as your current financial situation.

There are two broad types of [debt consolidation loans](https://www.investopedia.com/the-best-personal-loans-for-debt-consolidation-8762444): [secured and unsecured loans](https://www.investopedia.com/ask/answers/110614/what-difference-between-secured-and-unsecured-debts.asp). Secured loans use an asset, like [your home, as collateral](https://www.investopedia.com/debt-consolidation-affect-ability-buy-home-8424570).

[Unsecured loans](https://www.investopedia.com/terms/u/unsecuredloan.asp), on the other hand, are not backed by assets and can be more difficult to get. They also tend to have higher interest rates and lower qualifying amounts. With either type of loan, interest rates are still typically lower than the rates charged on credit cards. And in most cases, the rates are [fixed](https://www.investopedia.com/terms/f/fixedinterestrate.asp), so they won't rise over the repayment period.

With any type of loan, you'll want to prioritize which of your debts to pay off first. It often makes sense to start with the highest-interest debt and work your way down the list.

Here are a few more details about the most common ways to consolidate your debt.

### Personal Loans for Debt Consolidation

A personal loan is an unsecured loan from a bank or credit union that provides a lump sum payment you can use for any purpose. You repay the loan with regular monthly payments for a set period of time and with a set interest rate. [Personal loans](https://www.investopedia.com/the-best-personal-loans-8761582) usually have lower rates than credit cards, making them good for consolidating card debt.

> **Fast Fact**
>
> Some lenders offer debt consolidation loans specifically for consolidating debt. They are designed to help people who are struggling with multiple high-interest loans.

### Using Credit Cards for Debt Consolidation

A new card can help you reduce your credit card debt burden if it offers a lower interest rate.

As mentioned earlier, some credit cards offer an introductory period with 0% APR when you transfer your existing balances to them. These promotional periods often last from six to 21 months or so, after which the interest rate can shoot up into double digits. So it's best to pay off your balance, or as much of it as you can, as soon as possible. These cards might charge a fee of 3% to 5% of the transferred amount.

### Home Equity Loans: A Strategy for Debt Consolidation

If you are a homeowner who has built up equity over the years, a [home equity loan or home equity line of credit (HELOC)](https://www.investopedia.com/mortgage/heloc/) can be a useful way to consolidate debt. These secured loans use your equity as collateral and typically offer interest rates slightly above average mortgage rates, which are generally well below credit card interest rates.

> **Tip**
>
> Order your copy of Investopedia's What to Do With $10,000 magazine for more tips about managing debt and building credit.

### Consolidating Student Loans: What to Know

The federal government offers several [consolidation options](https://www.investopedia.com/articles/personal-finance/011916/student-loan-refinancing-pros-and-cons.asp) for people with student loans, including direct consolidation loans through the Federal Direct Loan Program. The new interest rate is the weighted average of the previous loans. Consolidating your federal student loans can result in lower monthly payments by stretching out the repayment period to as long as 30 years. But, this might mean paying more interest over time.

Private loans don't qualify for this program, although you may be able to consolidate them with another private loan.  

## Debt Consolidation and Your Credit Score

A [debt consolidation loan](https://www.investopedia.com/the-best-personal-loans-for-debt-consolidation-8762444) can boost your [credit score](https://www.investopedia.com/terms/c/credit_score.asp) in the long term. By reducing your monthly payments, you should be able to pay the loan off sooner and reduce your [credit utilization ratio](https://www.investopedia.com/terms/c/credit-utilization-rate.asp) (the amount of money you owe at any given time compared to the total amount of debt you have access to). This, in turn, can help boost your credit score, making you more likely to get approved by creditors and for better rates.

However, rolling over existing loans into a brand new one may hurt your credit score. Credit scores favor older debts with longer, more consistent payment histories.

## Qualifying for Debt Consolidation

Borrowers must meet the lender's income and [creditworthiness](https://www.investopedia.com/terms/c/credit-worthiness.asp) standards to qualify for a new loan. For example, for a debt consolidation loan, you may need to provide a letter of employment, two months' worth of statements for each credit card or loan you wish to pay off, and letters from creditors or repayment agencies.

## Does Debt Consolidation Hurt Your Credit Score?

Debt consolidation could temporarily affect your credit score negatively because of a credit inquiry, but it can help your credit score in the long term if you use it correctly. People who pay on time often see their credit score rise because they reduce missed payments and lower their credit utilization.

## What Are the Risks of Debt Consolidation?

[Consolidating debt](https://www.investopedia.com/credit-card-debt-consolidation-a-step-by-step-guide-8418444) might cost more in the long run, especially if you keep using your paid-off credit cards. There may also be a minor, short-term ding to your credit score.

## What Is the Best Way to Consolidate Debt?

The best way to consolidate your debt will depend on the amount you need to pay off, your ability to repay it, and whether you qualify for a relatively inexpensive loan or credit card. Fortunately, you have a number of options.

## What Is Debt Settlement?

Not to be confused with debt consolidation, [debt settlement](https://www.investopedia.com/personal-finance/debt-settlement-cheapest-way-get-out-debt/) aims to reduce a consumer's financial obligations rather than the number of creditors they have. Consumers can work with [debt-relief organizations](https://www.investopedia.com/the-best-debt-relief-companies-8763179) or [credit counseling](https://www.investopedia.com/terms/c/credit-counseling.asp) services to settle their debts. These organizations do not make actual loans but try to renegotiate the borrower's current debts with creditors.  

## The Bottom Line

Debt consolidation can be a useful strategy for paying down debt more quickly and reducing your overall interest costs. You can consolidate debt in many different ways, such as through a personal loan, a new credit card, or a home equity loan.

> **Article Sources**
>
> 1.  Federal Student Aid. "[What Are the Benefits and Downsides of Loan Consolidation?](https://studentaid.gov/help-center/answers/article/pros-and-cons-of-consolidation)"
>     
> 2.  U.S. Department of Education, Federal Student Aid. "[Consolidating Student Loans](https://studentaid.gov/manage-loans/consolidation)."