What Is Debt Consolidation, and Is It Right For You?
Debt consolidation is the act of taking out new debt and using it to pay off multiple old debts. After consolidating, you’ll only have one bill to pay (hopefully at a lower interest rate).
While this strategy could be an excellent way to streamline your budget and save money, it doesn’t make sense for everyone. Here’s what you need to know about debt consolidation so you can decide if it’s right for you.
- Debt consolidation means using one new loan or credit card to pay off multiple debts.
- Consolidating can help you save money if you qualify for a lower interest rate than what you’re currently paying.
- Debt consolidation is not a good choice if you can’t afford your new monthly payment or if you’re likely to continue charging new debt as you repay.
How debt consolidation works
Debt consolidation means paying off two or more smaller debts with one bigger debt, usually with a personal loan or a balance transfer credit card.
Debt consolidation is popular because you can save money on interest if you qualify for a lower annual percentage rate (APR) than what you’re currently paying. It also streamlines your budget since you’ll only have one bill to pay rather than several.
However, your new loan company may charge you an origination fee to consolidate your debt (but not always). And card issuers almost always charge a balance transfer fee.
Consolidating debt with a personal loan
May be best for borrowers who need more than six to 21 months to pay what they owe and/or for those who also have loans and medical bills to consolidate.
A debt consolidation loan is a type of personal loan. You can use it to consolidate credit cards, medical bills or personal loans.
The loan will come as a lump sum of cash to you. Then, you’ll use this cash to pay off your creditors. Some lenders can pay your creditors on your behalf, and may give you an interest rate discount if you opt in. This is usually called “direct pay.”
Debt consolidation loans have loan terms between 12 and 84 months, generally. That’s the length of time you’ll get to pay off your loan. You will pay interest while your loan is active, but most often, this interest won’t grow as long as you pay on time.
Some debt consolidation loans come with an origination fee.
If you have fair or bad credit, you may have to pay an origination fee of up to 10%. Origination fees are usually rolled into the loan so you won’t pay out of pocket. If you have excellent credit, you might not have to pay an origination fee at all.
Average debt consolidation loan rates by credit score
If you have a credit score of 680 or higher, it’s likely that you can save interest by consolidating your credit card debt with a personal loan.
According to LendingTree research that tracks credit card rates over time, the average credit card interest rate hovers around 24%. Compare that to the average debt consolidation loan rates below.
| Credit score range | Average APR |
|---|---|
| 800-850 (excellent) | 11.12% |
| 740-799 (very good) | 13.37% |
| 670-739 (good) | 21.52% |
| 580-669 (fair) | 29.70% |
| 300-579 (poor) | 32.31% |
Consolidating debt with a balance transfer credit card
Likely makes the most sense for borrowers who qualify for a 0% APR card and can pay their debt within 12 to 24 months.
A balance transfer credit card is a special type of credit card that is designed to absorb your current credit card debt. According to LendingTree research, borrowers with at least $5,000 in credit card debt could save $700 on average by moving their debt to a balance transfer card.
Many balance transfer cards have a 0% APR introductory period between 12 and 24 months. As long as you can pay off the card by the end of the intro period, you will not pay interest. Any debt left after your intro period ends is subject to interest from that point forward.
It is possible to use a balance transfer credit card to make purchases, but that’s not what it was designed for. APRs are high on purchases and accruing more debt defeats the purpose of debt consolidation.
Balance transfer cards charge balance transfer fees of around 3%-5% for each balance transferred. Almost all balance transfer cards have a balance transfer fee. Otherwise, the card issuer wouldn’t make money since most balance transfer cards have a 0% intro period.
On a 0% balance transfer card, it’s possible to skip interest if you can pay what you owe before the end of your introductory period.
Debt consolidation loans always come with interest but can be a better option if you need longer to pay your debt. Once a balance transfer card’s intro APR expires, the ongoing rate can be higher.
How to decide if a debt consolidation loan is right for you
If you’re juggling credit card debt, follow these steps to see if debt consolidation is right for you.
- Add up the debt you want to consolidate and get an average of your APRs. For instance, if you have three cards with APRs of 28%, 29% and 30%, your average APR would be 29%. That’s because 28 + 29 + 30 = 87, and 87/3 = 29.
- Prequalify for a loan in the amount you need to consolidate. This won’t impact your credit score.
- Compare your current average APR to your potential consolidation loan APR and see if consolidating will save you money. Also, be sure that any upfront fees you might pay to consolidate don’t wipe out any savings you might receive with a lower APR.
Debt consolidation pros and cons
Pros
- May skip paying interest if you qualify for a 0% APR balance transfer card and can pay what you owe before the intro period ends
- Debt consolidation loan rates are typically lower than credit card rates if you have good credit
- Will only have one debt bill to pay (your debt consolidation loan or balance transfer card)
- A debt consolidation loan with a longer loan term may result in a lower monthly payment (but more total interest)
Cons
- Might not save money if you have fair or bad credit
- Can come with fees (origination fee or balance transfer fee, depending on whether you get a loan or a balance transfer card)
- May end up worse off if you continue using your credit cards after you consolidate
Avoiding common debt consolidation mistakes
- Confirm consolidation will save you money: You can’t undo the process after you consolidate. You can quickly see if a debt consolidation loan is worth it by using LendingTree’s debt consolidation calculator.
- Don’t forget about fees: It’s important to consider fees, especially on balance transfer cards. Every card you consolidate is subject to a separate balance transfer fee.
- Make sure you borrow enough: If you don’t transfer/borrow enough to pay off your eligible debt, you’ll have to keep making payments on the leftover balances.
- Avoid missed payments during the payoff/transfer window: It can take two to 21 days for a balance transfer to go through. Loans are typically quicker. Still, stay in touch with your current creditors until your balances are paid off. A missed payment can greatly harm your credit. Payment history makes up 35% of your FICO Score.
- Don’t run balances back up after consolidating. You might end up worse off than you started if you don’t slow down your spending. Your credit cards don’t automatically get closed after consolidation.
- Shop around and compare rates. Every lender has its own way of calculating rates. It’s important to get quotes from multiple lenders to make sure that you’re getting the best deal.
How to compare debt consolidation loans with LendingTree
You could save an average of $1,659 on your personal loan simply by using LendingTree to compare offers and choosing the one with the lowest rate.
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Take two minutes to tell us who you are and how much money you need. It’s free, simple and secure.
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Frequently asked questions
Debt consolidation can affect your credit score in different ways at different times.
You might see a drop shortly after you consolidate, but as long as you make your payments on time, a debt consolidation loan could actually improve your credit score. Payment history makes up 35% of your FICO Score.
Paying off your credit cards also improves your credit utilization ratio, which is the amount of revolving credit you have available compared to the amount you’re using. Your credit utilization ratio plays a significant role in your FICO Score (30%).
However, a hard credit pull is likely when you formally apply for your debt consolidation loan. As a result, your score might drop by about five points for around a year.
Also, if you close your cards after consolidating, you could negatively impact your length of credit history. Length of credit history makes up 15% of your FICO Score.
It can, but it’s not guaranteed. Debt consolidation can lower your interest rate if you qualify for a lower APR than what you are currently paying. You might qualify for a lower APR if you’ve improved your credit score since taking on your debt, or if rates have dropped in general.
Also remember that your new APR must be low enough that it makes up for any upfront fees you might pay to consolidate, like origination fees or balance transfer fees.
No, debt consolidation and debt settlement aren’t the same thing. Debt consolidation is a personal finance strategy that helps you roll multiple debt payments into one, hopefully with a lower rate.
Debt settlement involves negotiating with your creditors to get rid of your debt. Some creditors might allow you to pay a lump sum that’s less than what you owe, since they’d rather get some payment than no payment at all.
Learn more about debt consolidation versus debt settlement.
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