What is Debt Consolidation? A Quick Way to Tackle Your Debt

If you’re juggling so many credit card and loan payments each month that you can only afford to make the minimum payments, it’s time to consider debt consolidation.

But what is it, and how does it work?

Table of Contents

Key points

Debt consolidation rolls your existing debts into one new loan
It typically gives you one lower monthly payment
It will only work for unsecured debts
It makes the most sense to consolidate debts if you qualify for a lower interest rate
The two primary methods are debt consolidation loans and balance transfer credit cards

How debt consolidation works

Debt consolidation rolls your old debt into one new loan. There are a few different ways that this can be done, but there are two primary methods: Getting a loan or using a balance transfer credit card.

Personal loans

Personal loans — also sometimes called debt consolidation loans — are unsecured loans through a lender or credit union. You get a lump sum payment and use that money to pay off all of your other loans. Then you repay that loan with one monthly payment for a predetermined timeframe with a fixed interest rate.

Pro tip: You will need to carefully weigh loan offers to ensure that there are no hidden costs or fees and that the loan amount is high enough to cover all of your other debts.

Balance transfer credit cards

Getting a new credit card will only help reduce debt if it has a lower interest rate. To lure new customers, many credit card companies will offer promotional periods with 0% APR when you transfer your balances onto the new card. These introductory offers usually range from 12 to 21 months. The cards aren’t totally free, though. You’ll have to pay a balance transfer fee of 3% to 5%. The drawback is that you’ll need a relatively good credit score (roughly 670 or more) to qualify.

Pro tip: Credit card companies are gambling that you won’t pay off your new card by the time the introductory rate ends. At that point, the interest rate will shoot up and you’ll lose almost any savings that the introductory offer provides.

If there’s no possible way you can pay the card off in full by the end of the introductory period (or qualify to refinance that loan when the promotion ends), you’ll be better off using a personal loan.

Pro tip: Even if you have bad credit, there are usually options for debt consolidation. Lenders and creditors know that debt consolidation increases the odds that you’ll repay what you owe.

Why debt consolidation works

The benefits of debt consolidation are two-fold:

Extra money each month: If you’re juggling multiple minimum payments and stretching your budget, rolling everything into one payment helps you lower the amount of money you must dedicate to monthly debt payments.
You pay less interest: In many cases, even if your loan term is longer, you’ll save money in interest due to the lower interest rate.

READ MORE: Why consolidate debt?

An example of debt consolidation

Let’s say you have $19,000 in debt, and you’re paying a total of $500 a month in minimum payments. If you consolidated those three credit card bills into one debt consolidation loan for $20,000 with a 10.99% APR and repaid it over the same five-year period, your monthly payment would fall to $434.75 per month, freeing up $65.25 per month in your monthly budget, and after paying your other loans off, you’d have $1,000 left over to put toward other expenses. Over the life of the loan, you’d save $4370.27 in interest.

Using the same numbers as the above example, if you took that same $19,000 in debt and the same $20,000 debt consolidation loan, but you repaid the loan over seven years instead of five, you’d still save almost $700 in interest and you’d cut your monthly payment by $157.66 per month.

Types of debt that can be consolidated

READ MORE: Types of debt to consolidate

Qualifying for a debt consolidation loan

Your credit score and creditworthiness will be used to determine your loan options.

You may need to provide documentation, including the following:

Proof of employment
Bank statements
Credit card and/or loan statements
W-2s
Pay stubs

DebtHammer can help

If all of this seems overwhelming, contact DebtHammer for a free consultation.

DebtHammer is not a lender. We offer loan broker services and will work to match you with one of the lenders in our network. We can compare more than 30 personal loan options to assess your eligibility and help you decide whether debt consolidation is your best next step.

This can save you the hassle of submitting multiple loan applications, with each one potentially decreasing your credit score.

Lenders we work with include OneMain Financial, Lending Club, SoFi, Happy Money, Upstart, LightStream, Avant, Upgrade, BestEgg and Universal Credit.

DebtHammer’s team of experts will help you compare your options to develop a customized strategy tailored to your financial situation. If a debt consolidation loan is not your best option, we will let you know and will review other options. There are no commitments or upfront fees.

Debt consolidation has a few downsides

Your credit score may fall: When you take out a new loan, the lender runs a hard credit inquiry, which will cause a temporary credit score decline. Your score should rebound in a few months if you make your payments on time.
You may pay more in interest: Even though you’re getting a new loan with a lower interest rate, the longer repayment term means you may end up paying more over the life of the loan.
Loans can have origination fees: Personal loans can include origination fees up to 8% of the total loan cost. Borrowers with the worst credit histories will pay the highest origination fees.

How debt consolidation affects your credit score

If you have good credit, it’s unlikely that debt consolidation will greatly impact your credit score. You may lose a few points for a few months due to the hard credit check, but your score will bounce back quickly.

However, they will almost certainly help borrowers with bad credit, particularly for those missing payments.

Here’s why:

On-time payments
Lower credit utilization
Improved debt-to-income ratio

Pro tip: There’s no reason why you couldn’t consolidate debts more than once. If you have poor credit, you could qualify for a higher-interest loan, but after a year or two, when your credit score has risen, you could start the process again in order to qualify for a lower interest rate.

Other debt relief and consolidation options

The bottom line

If your credit cards are maxed out or you run out of money well before the next paycheck, debt consolidation is a simple and inexpensive way to solve the problem.

Check your credit score and explore your loan options before you start the application process in order to minimize the impact the new loan will have on your credit score.