Debt consolidation is a two-fold strategy that combines existing debts, such as credit cards, medical bills, or other loans, into one new loan.
The aim is to simplify your payments while paying a lower interest rate than before. With less interest, more of your payment goes toward your balance, so you can become debt-free faster.
The Math Behind Debt Consolidation
Say you owe $12,000 spread across three credit cards averaging 22% interest, which is close to the actual average rate on cards that carry a balance, according to Federal Reserve data.
Putting $400 a month toward that debt would take about 44 months to pay off and cost you close to $5,600 in interest.
Roll that same $12,000 into a personal loan at 12% and pay the same $400 a month, and you’d be debt free in about 36 months, paying closer to $2,400 in interest, saving you roughly $3,200 and nearly a year of payments.
Options for Debt Consolidation
Personal loan: A bank, credit union, online lender, or other financial institution lends you a lump sum that you repay in monthly installments over a set term. The loan is unsecured, meaning it’s not backed by collateral like your house or car. That means your interest rate depends heavily on your credit score, although a borrower with good credit can qualify for a rate well below what credit cards charge.
Balance transfer card: Some credit cards let you move existing balances onto a new card offering a low or 0% introductory rate, typically for 12 to 21 months. You do need to pay off the balance before the promotional window closes. Once it ends, the rate usually jumps back up.
Home equity loan or HELOC: If you own your home, either a home equity loan or home equity line of credit (HELOC) lets you borrow against the value you’ve built up. The rate can be lower than an unsecured personal loan because your home is collateral. The caveat is that you can face foreclosure if you fail to make your payments. Both types of loans can also come with closing costs and fees, so read the fine print.
Nonprofit debt management plan: For people with worse credit, a nonprofit counseling agency can negotiate lower rates directly with your creditors and combine your payments into one monthly amount the agency distributes on your behalf. This route is an option for those who can’t qualify for a personal loan or balance transfer card.
What Debt Consolidation Does Not Do
Debt consolidation doesn’t erase what you owe. It only restructures how you pay it back. Don’t confuse it with debt settlement, where a company negotiates with creditors to accept less than your full balance in exchange for steep fees and serious, lasting damage to your credit.
Also note that debt consolidation only saves you money if the new rate is genuinely lower than what you’re currently paying. Find out any origination or transfer fees, and the term length of the loan. A lower monthly payment stretched over more years can end up costing more in total interest.
Finally, make sure you stop putting new charges on the credit cards you just paid off. Carrying both the new loan and fresh card balances will leave you worse off than when you started.
Applying for a new consolidation loan or card will trigger a hard inquiry that may knock a few points off your credit score in the short term, but on-time payments toward your new loan tend to help your score recover and grow over the long term.
