Pros and Cons of Consolidating Your Debt

Managing multiple monthly debt bills with different due dates and payment amounts is a headache, not to mention a strain on your budget. Debt consolidation, where you combine multiple debts into a single payment, can make the process easier.

While debt consolidation could improve your finances, it’s not the right move for everyone. Here’s how this debt management strategy works, and the pros and cons of using it.

How to consolidate debt

Debt consolidation entails taking on a new loan or line of credit with a lower interest rate that’s large enough to cover the debts you want to consolidate. This enables you to pay off multiple existing loans with one new loan, leaving you with a single interest rate and monthly payment.

You can consolidate most types of debt, including credit card debt, auto loans, personal loans and medical debt. The most common methods to consolidate debt are personal loans, balance transfer credit cards and home equity loans or lines of credit (HELOCs).

Which option is best for you will depend on your finances. Most people pursuing debt consolidation seek out loans that have lower interest rates than they’re currently paying so they can save money and pay off their debts faster.

Homeowners can often secure lower interest rates by using their house as collateral with a home equity loan or HELOC. If you don’t own a home — or haven’t built up much equity — a personal loan is an option. These fixed-rate installment loans are convenient because you pay the same amount each month, which is useful for budgeting.

A balance transfer credit card that comes with a low “teaser” annual percentage rate (APR) on balances as well as purchases for a period of time — say, one or two years — can be a useful tool for debt consolidation, with a couple of caveats. You’ll need to get a credit limit high enough to cover the debts you want to consolidate, which makes this option better for people with smaller amounts of debt. The other thing to keep in mind is that you have to pay off the transferred balance before the promotional period ends, and avoid the temptation to charge new debt onto that card in the future. Ultimately, the best debt consolidation option for you will be the one that saves you the most on interest while fitting comfortably into your budget.

Regardless of the method, debt consolidation typically requires a good-to-excellent credit history, which shows the lender that you have a record of on-time payments. While borrowers with fair to poor credit may be able to get approved for some types of debt consolidation loans, the terms might not be good enough to justify moving your money.

Once you’ve researched your options for consolidating debt, look for a lender and apply for a new loan or line of credit. Use the funds from the new loan to pay off all the balances you want to consolidate. (With a balance transfer card, note that the credit card companies usually handle the transfer of the balance. Also note that there may be a deadline by which balance transfers have to be completed in order to qualify for the promotional rate.)

Then, you make a single payment every month to pay down the consolidation loan. It’s important to make on-time payments and be aware of the loan terms, especially due dates and deadlines, such as the end of a credit card’s promotional period. Debt consolidation only works if you are actually able to pay off the new loan on time.

Pro tip: Want a more in-depth explanation of how and when to consolidate debt? Read our debt consolidation guide.

Pros of debt consolidation

Depending on your financial goals, debt consolidation can have significant advantages. If you’re looking to pay off debt as quickly as possible, it could help you save money. If you need to reduce the amount you’re spending on bills each month, it could free up some money in your budget. Here’s a look at the most common benefits associated with consolidating debt.

Simplify your monthly payments

Remembering to pay all your bills on time can be challenging when you’re juggling multiple debt payments every month. Rolling all — or most — of your debts into a single payment can help you stay organized and avoid late or missed payments.

Save money on interest and pay off debt faster

The best debt consolidation loans can enable you to get out of debt faster by freeing up more cash to pay down what you owe. With a lower interest rate, more of your money will go toward the loan principal each month, enabling you to save money and pay your debts down more quickly.

Reduce monthly spending on debt

If you need to free up money to improve your monthly cash flow, debt consolidation can help with that, too. You want to replace high-interest debt with a lower-interest loan, then take the monthly savings from the reduced interest and use that to pay other bills. You may even be able to get approved for a consolidation loan that has a relatively low interest rate and a longer repayment term, further reducing your monthly spending on debt. There is a tradeoff here, though: While your monthly payment might be lower, you’re not technically “saving” money because the longer loan term means you will pay more in interest over the life of the loan.

Improve your credit score over time

When you first take out a debt consolidation loan, your credit score is likely to dip slightly, since you’re applying for a new loan. But that drop should be short-lived. As you make on-time payments on the new loan and reduce your overall debt, your credit score should improve.

Cons of debt consolidation

Like most financial moves, there are potential downsides to debt consolidation. It’s important to understand them before you pursue the strategy to ensure you’re making the best decision for your finances.

Interest rates may not be favorable

Many benefits of debt consolidation hinge on getting a lower interest rate compared to the rates on your existing debts. But that might not be possible, especially if you have fair or poor credit. For that reason, debt consolidation is a strategy best-suited for borrowers with strong credit scores. Borrowers with lower credit scores might get a loan offer that has a better APR than high-interest credit cards but is still higher than other debts, such as a car loan, you might have. This could still be helpful, if you need to simplify your bills or spread your payments out over a longer term. But in that case, you’ll have to weigh the other potential downsides of consolidation carefully to decide whether it’s still worth it.

Upfront costs are likely

Most lenders charge upfront fees on the products you might use to consolidate debt. Home equity loans or lines of credit have origination fees and closing costs that range from 1% to 5% of the total loan amount. Personal loans also have origination fees, which can be as high as 10% of the loan balance, wrapped into their APRs. Balance transfer credit cards typically charge a fee of between 3% and 5% of the amount transferred.

It could allow you to fall deeper in debt

Debt consolidation only works if you’re able to pay off the new loan on time. If you’re still accruing debt — especially high-interest debt like credit cards — taking a new loan or credit line is a risk. You could end up even further in debt and worse-off financially than before debt consolidation. If your debt consolidation loan is backed by your home equity, you could even risk losing your home.

Is debt consolidation a good idea?

Consolidation might seem like an easy way to get debt payments under control. For some borrowers, it certainly can be — especially if you get approved for a loan with a lower interest rate than your current debts and you have the discipline to pay it down and avoid accruing additional debt.

It’s important to keep in mind, though, that debt consolidation won’t magically eliminate your debt. You’ll still have to pay off the principal you owe, even though you’re getting a break on the interest. It’s a good idea to go over your finances and make sure that you understand why you accumulated your debts in the first place. If you’re spending more than you’re earning on a regular basis, taking out another loan won’t help.

Finally, if you’re struggling to make even the minimum payments on your debts or you’ve already missed several payments, debt consolidation probably can’t help you get a handle on your situation. In that case, it may be time for you to consider alternative options to get out of debt, such as a debt management plan, where you work with a credit counseling agency. With these plans, you typically pay a small monthly fee to the credit counseling agency, which develops a repayment plan that often involves combining multiple debt payments into one and getting a lower interest rate. Another option is debt relief, which often involves working with a debt settlement company that can help you renegotiate the agreements you have with creditors, ideally reducing your debt principal and eliminating penalty fees.

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