What is Debt Consolidation?
Debt consolidation combines multiple debts into a single loan, ideally with a lower interest rate. Instead of juggling multiple payments to different creditors, you make one payment to one lender.
The goal is to reduce your total interest paid, lower your monthly payment, and simplify your financial life. However, consolidation isn't always the right choice — the math has to work in your favor.
How Debt Consolidation Works
- Add up all your current debts
- Apply for a consolidation loan for that total amount
- Use the loan to pay off all existing debts
- Make single monthly payments on the new loan
- Your old accounts are now paid off (or closed)
Example
Types of Consolidation Loans
| Type | Typical Rate | Best For |
|---|---|---|
| Personal Loan | 6-20% | Good credit, unsecured debt |
| Balance Transfer Card | 0% intro, then 15-25% | Smaller balances, can pay off in 12-18mo |
| Home Equity Loan/HELOC | 5-10% | Homeowners, large amounts |
| 401(k) Loan | Prime + 1-2% | Last resort only |
| Debt Management Plan | Reduced rates | Working with credit counselor |
Secured vs Unsecured
When Consolidation Makes Sense
Good Candidates
- Your consolidation rate is significantly lower than current rates
- You can afford the monthly payment reliably
- You won't run up new debt on paid-off cards
- You've addressed the spending habits that caused the debt
- Your credit score qualifies you for good rates
Math That Works
| Current Situation | Good Consolidation | Bad Consolidation |
|---|---|---|
| Avg Rate: 22% | New Rate: 10% | New Rate: 18% |
| Total Interest: $8,000 | Total Interest: $3,500 | Total Interest: $7,200 |
| Saves: — | Saves: $4,500 | Only saves: $800 |
The rate difference needs to be substantial
When Consolidation Doesn't Work
- Consolidation rate isn't much lower than current rates
- You extend the term so long you pay more total interest
- You rack up new debt after consolidating
- Origination fees eat up any savings
- You don't qualify for good rates due to credit score
The Biggest Danger
Alternatives to Consolidation
Debt Avalanche
Pay minimum on all debts, then put extra money toward the highest interest rate debt. Most mathematically efficient.
Debt Snowball
Pay minimum on all debts, then put extra money toward the smallest balance. Provides psychological wins as debts get eliminated.
Balance Transfer Card
Transfer balances to a 0% APR promotional card. Best for smaller amounts you can pay off during the intro period (usually 12-21 months).
Negotiate with Creditors
Ask current creditors for rate reductions. Many will lower rates to keep your business, especially if you have a good payment history.
Understanding the Fees
| Fee Type | Typical Amount | Notes |
|---|---|---|
| Origination Fee | 1-6% of loan | Common on personal loans |
| Balance Transfer Fee | 3-5% of amount | On credit card transfers |
| Prepayment Penalty | Varies | Check before signing |
| Annual Fee | $0-$500 | Some credit cards |
Include Fees in Your Calculation
Impact on Credit Score
Short-Term Effects
- Hard inquiry from loan application (-5 to -10 points)
- New account lowers average account age
- Closing old accounts may reduce length of credit history
Long-Term Benefits
- Lower credit utilization (big positive)
- Consistent on-time payments build history
- Reduced debt-to-income ratio
Net Effect
Frequently Asked Questions
Q: Will I actually save money?
A: Only if the math works — lower rate, reasonable term, fees less than savings. Use this calculator to compare. Some people consolidate and pay MORE due to longer terms or fees.
Q: Should I close credit cards after consolidating?
A: Not necessarily. Closing cards reduces your credit limit (hurts utilization ratio) and shortens credit history. Consider keeping them open with $0 balance, but don't use them.
Q: What credit score do I need?
A: For the best personal loan rates, you'll want 700+. Fair credit (640-699) can still get loans, but at higher rates. Below 640 may require secured loans or credit union options.
Q: Is debt consolidation the same as debt settlement?
A: No. Consolidation pays debts in full with a new loan. Settlement negotiates to pay less than owed. Settlement severely damages credit and is usually a last resort before bankruptcy.
Q: Can I consolidate student loans too?
A: Federal student loans have their own consolidation programs. Be careful about consolidating federal loans into private loans — you lose federal protections like income-driven repayment.
Q: How long should my consolidation term be?
A: As short as you can afford. Longer terms mean lower payments but more total interest. Aim for 3-5 years for most debt consolidation loans.
Your Action Plan
- List all debts with balances, rates, and minimums
- Calculate your weighted average interest rate
- Check what consolidation rates you qualify for
- Use this calculator to compare total costs
- If consolidation wins, apply for the best offer
- Pay off all existing debts with the loan
- Commit to not creating new debt
- Make payments on time, consider autopay
Results are estimates based on the inputs provided. Actual loan terms depend on your credit profile, income, and lender policies. This is not financial advice. Consider consulting with a certified credit counselor for personalized guidance.