5 Benefits of Debt Consolidation
If you’re struggling to juggle multiple debts at once, consolidating debt may make sense for your wallet. Debt consolidation is the process of rolling multiple debts into a single loan, ideally with a lower interest rate. As long as you have good credit and can budget properly to make payments each month, the benefits of debt consolidation could include savings, paying off your debt faster and a boost to your credit score.
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How does debt consolidation work?
Debt consolidation is when you roll multiple debt payments into one, typically using a personal loan, balance-transfer credit card or home equity loan. This process combines your various monthly payments, making your debt repayment easier to track. Some lenders even offer the option to send your loan funds directly to your original creditors.
Debt consolidation loans are typically unsecured — this means that instead of collateral, lenders will instead focus on your credit history and score to determine your creditworthiness. Since these types of loans are a form of personal loans, you’ll receive payment in the form of a lump sum, have fixed monthly payments and may have to pay an origination fee — a one-time administrative fee taken out of your loan funds.
5 benefits of debt consolidation
While it may not be an option for everyone, many borrowers may find that the benefits of a debt consolidation personal loan include streamlining debt repayment, saving money on interest payments and a higher credit score.
- You can save money
- You can simplify your monthly budget
- You may pay off your debt faster
- You may lower your monthly payments
- Your credit score may increase
1. You can save money
If you’re able to secure a lower annual percentage rate (APR), you could save yourself hundreds (if not thousands) of dollars over the life of your loan. Your APR is the measure of how much interest and fees you’re paying on the loan.
To find out whether you can save money by taking out a debt consolidation loan, research the personal loan requirements for every lender you’re considering and shop around to compare rates. Lenders typically take into account factors like your credit score, your debt-to-income ratio and income.
Here’s a look at how consolidating credit card debt with a personal loan can save you money.
|Credit card||Personal loan|
|Repayment terms||24 months||24 months|
|Minimum monthly payment||$403||$373.64|
|Total cost of debt||$9,684||$8,967.44|
*2022 Q4 Federal Reserve data. Available APRs may differ based on your location and credit score.
2. You can simplify your monthly budget
Managing multiple due dates and accounts can add stress to your life and your budget. If you accidentally miss a payment, for instance, you’ll probably have to pay a late fee and your credit score will take a hit.
One of the benefits of debt consolidation loans is that they combine at least some, if not all, of your debt into one payment. You’ll only have to track a single account every month instead of managing multiple accounts and debt payments.
3. You may pay off your debt faster
Unlike revolving forms of debt like credit cards, personal loans come with fixed repayment terms that provide an exact end date. To pay your debt off faster, you can apply for a short-term loan with terms as brief as 12 or 24 months.
Not only can you pay off a short-term loan faster, but you’ll pay less in interest overall. However, keep in mind your minimum monthly payments will be higher than they would be with a long-term loan.
4. You may lower your monthly payments
If you’re struggling to make ends meet, a debt consolidation loan may make your monthly payments more affordable. A long-term loan can result in smaller monthly payments, though you may end up paying more in interest over the life of your loan.
To determine how much you can afford to pay per month, use a debt consolidation calculator to estimate your savings based on details like APRs, debt amounts and loan terms. Here’s a look at how the length of your repayment term can impact the overall cost of borrowing.
|Short-term loan||Long-term loan|
|Length of debt repayment||3 years||5 years|
|Total cost of debt||$9,456.05||$10,484.30|
*2022 Q4 Federal Reserve data
5. Your credit score may increase
As you pay off your debt consolidation loan, your credit utilization ratio will gradually decline, and that can help boost your credit. On top of that, your on-time payments will be reported to the credit bureaus, further boosting your credit score.
However, applying for any new loan can hurt your credit score, as it’ll require a hard credit inquiry. This allows lenders to examine your credit history to determine your creditworthiness, but should only cause your credit score to go down by about 5 points.
Is debt consolidation a good idea for you?
Debt consolidation may help you save money and make paying off your debt easier. But for some borrowers, this strategy may not make sense and could even make your financial position worse. To find out whether debt consolidation is a good idea, you’ll want to compare the cost of your current debt to the cost of a new consolidation loan.
For instance, if you have a bad credit score, you may not qualify for a personal loan with decent rates, if at all. Debt consolidation loans can have APRs as high as 36%.
Debt consolidation might be a good fit for you if lenders offer you a lower APR than what you’re currently paying. If not, consolidating your debt may end up costing you more in the long run.
Frequently asked questions
A debt consolidation loan may have a negative impact on your credit score, since lenders will run a hard credit inquiry; this can cause your credit score to temporarily drop by a handful of points. However, as you pay off your loan, your credit utilization ratio will decrease, which can have a positive affect on your score.
When you take out a debt consolidation loan, the hard credit inquiry can stay on your credit report for up to two years. If you’re more than 30 days late on a loan payment, that can also show up on your credit report. Since your payment history makes up 35% of your FICO Score, missed payments can have a detrimental affect on your credit and may stay on your report for up to seven years.
If you’re unable to get a lower interest rate than what you’re currently paying, debt consolidation may not be the route for you. To get a low interest rate, you’ll want to make sure your credit profile is strong. If your score needs work, it is smart to work on improving your credit score before applying for a new loan.