Debt consolidation involves combining multiple unsecured debts into one bill, which can be helpful if you’re overwhelmed by an assortment of monthly payments. You can consolidate a variety of debts, including credit cards, payday and personal loans, utility bills and medical expenses. So instead of having to send a separate payment to each creditor or collector every month, you’d make just one. This can help eliminate missed or late payments and ensure that you’re addressing all your debts.
Debt consolidation loans can be a great option, not only because it streamlines monthly payments, but also because, in many situations, you may get a reduced interest rate and lower total monthly payment.
Maggie Germano, a certified financial education instructor and financial coach in Washington, D.C., said this topic comes up “pretty frequently” with her clients. “Most of my clients have credit card debt,” she said. “It can be really overwhelming when you have five credit cards to pay and you don’t even know where to start. I’ll sometimes float the idea of debt consolidation so they only have one bill to pay or so they can have a lower interest rate.”
There are many options to consider when deciding to consolidate debt, some of which work better in different situations.
A word to the wise, though: Debt consolidation loans aren’t for everyone struggling with debt. Determining which method will benefit you the most will involve some homework and some calculations … or a visit to a debt counselor.
Debt consolidation can take many forms, including a personal loan, a balance-transfer credit card, a home equity line of credit (HELOC) and a debt management plan, among others. (We’ll get into the details of those options later on.)
No matter what strategy suits you best, the idea is the same: Lump together all or most of your debts into a single payment as a way to save money, simplify your finances … or both.
For example, if you have multiple high-interest credit card debts and outstanding medical bills, you may want to take out a personal loan to repay those debts. Then you can focus on repaying that personal loan, which requires just one monthly payment and, ideally, has a lower interest rate than what you were paying across multiple debts (it may not have a lower rate, but it’s in your best interest to find the lowest one you can).
The specifics of how consolidation works will vary by the type of debt you have and the method you choose.
Any type of personal debt can be consolidated. This includes but is not limited to:
“Depending on the type of consolidation, there are firms that will negotiate any sort of debt that’s out there,” said Rod Griffin, director of consumer education for the credit bureau Experian. “There may be restrictions by the lender, but generally, most debts can be consolidated or settled.”
While consolidating debt certainly has merits, it is not the right choice for every individual. Above all, the approach has to match the need and the comfort level of the borrower. Some people prefer a DIY debt management plan, while others benefit from simplified singular payment of a consolidation loan.
“It really depends on the person and the type of debt,” Germano said. “A debt consolidation loan can help you manage your payments easier and less stressfully. That makes sense for a lot of people.”
She added: “But some people would rather tackle a debt management plan themselves. If you know that wouldn’t be overwhelming to you, that makes a lot of sense. If you know that you’re not great at keeping up with your payments without someone reminding you to, looking into credit counseling or debt management options is a good idea.”
According to Germano, a good rule of thumb is this: Consolidation is not a good option if your debt is more than 50 percent of your income. It is also not a fit if you do not have a consistent source of income that more than covers your monthly payment. Finally, bad credit can keep you from getting a good interest rate, which negates the purpose of a consolidation loan.
Germano also explained that embarking on consolidation can be futile without attempting to make changes to your financial habits.
“I usually recommend financial coaching to work on the habits and the emotions and the history behind money issues,” she said. “If you don’t make any changes in that realm, then you’re probably going to grow your debt again.”