What is debt consolidation and how does it work?

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Debt consolidation can help you take control of your high interest credit card debt. Find out how it works and if it’s the right option for you. (Shutterstock)

Whether you owe more or less than average, managing your debt can feel overwhelming, especially if you’re juggling multiple monthly payments.

Debt consolidation can make it easier to pay off your debts and allow you to get out of debt sooner or save on interest charges. Here’s how debt consolidation works and the different methods you can use to consolidate multiple balances.

A personal loan is a tool you can use to consolidate high interest debt. Credible, it’s easy to view your prequalified personal loan rates from various lenders, all in one place.

What is debt consolidation and how does it work?

Debt consolidation is the process of combining two or more debts into one account. You can usually do this with a single loan, which you will then use to pay off your current balances. A debt consolidation loan can pay off a handful of selected accounts or even satisfy all of the debts you currently hold.

All paid accounts will be erased or closed, and you will then be responsible for repaying the debt consolidation loan as agreed.

With a debt consolidation loan, you can:

  • Lock in a lower interest rate
  • Reduce the amount of your monthly payments
  • Get out of debt sooner
  • Simplify your repayment schedule

In some cases, you may be able to accomplish all of the above.

Common Debt Consolidation Methods

You can consolidate your debt in several different ways. Here are some of the most common options.

Personal loan

You can find personal loans offered by banks, credit unions and online lenders. They provide a one-time cash lump sum, which you can then use to pay off existing debt (or whatever else you need). Personal loans are installment products, so you repay them over a fixed period with fixed monthly payments.


  • Some best personal loans allow you to borrow up to $100,000, making it easy to consolidate multiple debt balances.
  • Funding can be done the same day or the next business day.
  • Interest rates can be competitive for good borrowers.

The inconvenients

  • You are responsible for using the funds to pay off existing balances (although some lenders offer to do this for you).
  • To get the lowest interest rates available, you’ll need good to excellent credit.
  • You may need to meet a lender’s minimum income requirements to qualify.

Visit Credible for compare personal loan rates from various lenders, without affecting your credit.

Balance transfer credit card

Balance transfer credit cards allow you to transfer balances from one credit account to a new credit card account. If a new card offers a lower interest rate – or even an introductory APR of 0% for a certain period of time – moving balances may save you a lot of money on your credit card debt.


  • Introductory or promotional offers can reduce or even eliminate interest charges.
  • If you already have a balance transfer credit card, you can consolidate your debt at any time without having to apply for a new card.
  • Some balance transfer cards may come with additional rewards or benefits for using the card.

The inconvenients

  • Some issuers charge a balance transfer fee, which can often be between 3% and 5% of the amount you transfer.
  • You can only transfer balances up to your card’s credit limit. If your current debts exceed your credit limit, you will not be able to consolidate all of your debts on the card.
  • After the card’s promotional period ends, your remaining balance is subject to the card’s typical interest rate, which may be higher than personal loan interest rates.

401(k) loan

Your retirement account could be the biggest pool of savings you have. Accessing these funds with a 401(k) loan can be a quick way to consolidate and clear some debt. But it’s rarely the best choice, and not all employers allow 401(k) loans.


  • Retirement accounts can offer more funds than you can get with a personal loan or credit card.
  • Any interest is paid directly into the account, so you’re essentially paying yourself interest on the loan.
  • You won’t have to undergo a credit check to borrow money.

The inconvenients

  • If you quit your job, you may have to repay the entire loan.
  • You’ll miss out on the potential to grow the amount you withdraw, which can impact your long-term savings goals.
  • If you do not repay the loan as agreed, you will be in default; defaulted loans are considered early withdrawals and will be subject to penalty fees and taxes.

Debt management plan

A debt management plan (DMP) is a strategy put in place by a non-profit credit counseling agency. A credit counselor will negotiate on your behalf with your creditors. You will make a monthly payment to the credit counseling agency, and the agency will pay your creditors for you. A debt management plan is not a loan, but it can make getting out of debt more manageable.


  • You will only have one monthly payment to follow.
  • Credit counselors will work with your lenders and creditors to create a debt repayment strategy that’s right for you.
  • Depending on the plan, you may be able to reduce your monthly payment amount and interest charges.

The inconvenients

  • Creditors can report debt management plans to credit bureaus, which can affect your credit score.
  • Plans often charge a monthly fee, which can increase your overall costs.
  • Paying off your debt in full can take up to five years under a debt management plan.

When debt consolidation makes sense

Here are some situations where debt consolidation can make the most sense.

You want to reduce your number of monthly payments

Rather than juggling multiple payments and due dates each month, consolidating your balances can result in a single payment with a single due date.

You have a decent credit score

If you have good credit, you may be eligible for a low interest loan at a competitive rate, which can be much lower than what you pay on other debts, such as credit cards. This can save you a lot of money in interest over time.

You focus on controlling your expenses

Debt consolidation can wipe out your revolving account balances, which could make it tempting to start spending again and accumulate more debt. If you’re committed to getting out of debt and focused on achieving your financial goals, debt consolidation can be a solid strategy.

If you are ready to apply for a debt consolidation loan, Credible allows you to compare personal loan rates so you can find the one that suits your needs.

When debt consolidation doesn’t make sense

As with any financial strategy, debt consolidation doesn’t make sense for everyone. Here are a few times when you might want to reconsider consolidating your debts.

You have a small debt that can be paid off quickly

Debt consolidation is a great strategy for paying off various balances, but it can come at a cost. If you only have a small amount of debt, consider whether another strategy (such as snowballing or debt avalanche) might be better, rather than paying personal loan origination fees or balance transfer credit card fee.

Your credit score may prevent you from qualifying for a lower interest rate

If you are trying to get a credit card or bad credit personal loan, you may not qualify for a lower interest rate than you pay on your existing debt. If you can’t get a lower interest rate or an introductory balance transfer offer, consolidating your debt might not be worth it.

You can’t change your spending habits

When you are in debt, you may dream of settling your outstanding balances. But once you do, the temptation of that $0 balance can sometimes lead to further spending.

If you think you might be tempted to accumulate those balances again, consider whether or not you should consolidate.

Michael M. Tomlin