What is debt consolidation and should I consolidate?

Debt consolidation consolidates multiple debts, usually high-interest debts such as credit card bills, into one payment. Debt consolidation might be a good idea for you if you can get a lower interest rate. This will help you reduce your total debt and reorganize it so you can pay it off faster.

If you are facing a manageable amount of debt and just want to rearrange multiple bills with different interest rates, payments, and due dates, debt consolidation is a good approach that you can tackle on your own.

How to consolidate your debt

There are two main ways to consolidate your debt, both of which concentrate your debt repayments on one monthly bill.

  • Obtain a 0% interest, credit card with balance transfer: Transfer all your debts to this card and pay the balance in full during the promotional period. You will likely need good or excellent credit (690 or higher) to qualify.

  • Benefit from a fixed rate debt consolidation loan: Use the loan money to pay off your debt, then repay the loan in installments over a set period. You may qualify for a loan if you have bad or good credit (689 or less), but borrowers with higher scores will likely qualify for the lower rates.

Two additional ways to consolidate your debts are to subscribe to a home equity loan Where 401(k) loan. However, both of these options come with risks — for your home or your retirement. In any case, the best option for you depends on your credit rating and profile, as well as your debt to income ratio.

debt consolidation calculator

Use the calculator below to see whether or not it makes sense for you to consolidate.

When debt consolidation is a smart decision

A successful consolidation strategy requires the following:

  • Your monthly debt payments (including your rent or mortgage) do not exceed 50% of your monthly gross income.

  • Your credit is good enough to qualify for a credit card with a 0% interest period or a low interest debt consolidation loan.

  • Your cash flow routinely covers your debt repayments.

  • If you choose a consolidation loan, you can pay it off in five years.

Here’s a scenario where consolidation makes sense: Suppose you have four credit cards with interest rates ranging from 18.99% to 24.99%. You always make your payments on time, so your credit is good. You may qualify for an unsecured debt consolidation loan at 7%, a significantly lower interest rate.

For many people, consolidation reveals a light at the end of the tunnel. If you take out a three-year loan, you know it will be paid off in three years, assuming you make your payments on time and manage your expenses. Conversely, making minimum payments on credit cards can mean months or years before they are paid off, while accumulating more interest than the original principal.

Consolidate your debt if you can get a loan on better terms and/or it will help you make your payments on time. Just make sure that this consolidation is part of a larger deleveraging plan and that you’re not accumulating new balances on the cards you’ve consolidated. Learn more how to tackle credit card debt.

A personal loan allows you to repay your creditors yourself, or you can use a lender who sends money directly to your creditors. Discover the steps necessary to get a personal loan.

Debt consolidation can improve your credit if you make payments on time or if the consolidation reduces your credit card balances. Your credit can be affected if you increase your credit card balances again, close most or all of your remaining cards, or miss a payment on your debt consolidation loan. Learn more about how debt consolidation affects your credit score.

When Debt Consolidation Isn’t Worth It

Consolidation is not a magic bullet for debt problems. It doesn’t address the overspending habits that create the debt in the first place. This is also not the solution if you are burdened with debt and have no hope of repaying it even with reduced payments.

If your debt is low — you can pay it off in six months to a year at your current rate — and you’d only save a negligible amount by consolidating, don’t bother.

If your total debt is more than half of your income and the above calculator reveals that debt consolidation is not your best option, you better ask for debt relief than treading water.

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Michael M. Tomlin