Debt Consolidation Pros & Cons – Wise Strategy or Risky Move
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When your monthly bills include high-interest credit cards or other loans where you know you’re overpaying in interest charges, you might consider debt consolidation. The idea is to get control over multiple debt payments and combine them so you only have a singular monthly bill. It might lower your monthly payment and save money, which can be your budget's financial lifeline. But it’s not without drawbacks either, and these points should be carefully considered before going down this path.
In this article
What is debt consolidation?
First, let’s discuss what debt consolidation is and isn’t. It’s simply when you combine your multiple debt payments into one monthly payment. You achieve this by taking out a new loan and paying off the multiple debts you wish to combine. You can almost think of it as refinancing several loans into one new one.
The new loan can either be a personal loan — often called a debt consolidation loan – or use a balance transfer option from a credit card to pay off credit card debt. It works the same way with a line of credit as well.
You can use secured loan options, too, including a home equity line of credit or home equity loan, where you borrow against the equity in your property and pay off your debts. No matter the loan type, you can pay off other credit card debts, medical debts, or possibly other personal loans.
Keep in mind debt consolidation is not the same as debt settlement. While debt consolidation is simply combining several debts into one payment, it doesn’t reduce the amount of debt you owe. Debt settlement is a completely different strategy, where you negotiate with your creditors (either on your own or with a debt settlement company) to lower the amount you owe and structure a repayment plan.
Millions struggle with debt. We help them move on with their lives.
- End your debt stress with a proven, affordable debt relief program. Our consultants will guide you through every step.
- Everyone’s financial situation is different. That’s why we start by giving you a free debt analysis and create a custom solution based on your unique needs and goals.
- Let us help you solve your debt problems and move forward with improving your overall financial health.
Not available in CO, HI, ND, OR, RI, VT, WA, WV, WY, MN, DE, IA.
Pros of debt consolidation
There are numerous reasons why people turn to debt consolidation as part of their overall debt management strategy. Here are some of the most common reasons a borrower might choose debt consolidation.
Only one bill to manage
One of the most obvious benefits is having one monthly payment versus several to keep track of each month. This makes running your household budget and keeping track of bills easier. And if you’ve ever accidentally paid a bill past the due date simply because you couldn’t keep up with the due date, then you might especially appreciate this point.
There’s another benefit, too – it lifts some of the mental load we all feel when dealing with our finances. Getting rid of the mental energy it takes to keep track of multiple debts may be enough to convince anyone that debt consolidation is the way to go.
It saves money if your interest rate is lower
Another major benefit is the possibility of lowering your interest rate with the new loan. Whether you take advantage of a promotional 0 percent introductory APR balance transfer rate with a credit card or qualify for a lower personal loan interest rate, you can save serious cash by reducing your rate.
While this sounds like a no-brainer right off the bat, you might not automatically save money over the life of the loan. You have also to factor in any additional fees for the loan, such as an origination fee or balance transfer fee. Save money if you factor in these fees plus your new interest rate.
It makes room in your budget
When you go through debt consolidation, not only does the interest rate determine your monthly payment, but so does the repayment term. You may have 18 months, two years, five years, or longer to repay the balance. The longer the repayment term, the lower your monthly payment is. When you reduce your monthly payment, you can free up money in your budget and use it for something else.
You can use the extra in your budget towards an emergency fund, pay off debts not covered by the debt consolidation loan, or whatever other daily expenses you have. In other words, it gives your budget a little more flexibility thanks to the extra wiggle room.
It can improve your credit score
Initially, when you apply for a debt consolidation loan or balance transfer credit card, your credit score might take a slight hit because of a hard credit inquiry. After this, though, your credit score can improve. For starters, by paying off multiple debts (and not closing the accounts), you decrease your overall credit utilization — the percentage of credit you use versus what’s extended to you.
Another way to improve your score is by making on-time payments with your new loan. Your payment activity is reported to the three credit bureaus monthly, and your new loan is no exception. On-time payments positively impact your credit score or help you maintain good credit.
Related: Best Debt Consolidation Companies
Millions struggle with debt. We help them move on with their lives.
- End your debt stress with a proven, affordable debt relief program. Our consultants will guide you through every step.
- Everyone’s financial situation is different. That’s why we start by giving you a free debt analysis and create a custom solution based on your unique needs and goals.
- Let us help you solve your debt problems and move forward with improving your overall financial health.
Not available in CO, HI, ND, OR, RI, VT, WA, WV, WY, MN, DE, IA.
Cons of debt consolidation
You might be sold on the idea already, but you should know the downsides of a debt consolidation loan.
Additional fees
As mentioned, there are fees associated with debt consolidation in addition to interest charges. If you use a personal loan to consolidate, the lenders may charge an origination or processing fee. If you use a balance transfer credit card offer, there is typically a 1% to 5% transfer fee based on your transfer balance. If there are fees, be sure to calculate these into the cost of the loan so you know if you’re saving any money in the long run.
You may not qualify for a lower interest rate
There is no guarantee you’ll qualify for a lower interest rate, and depending on your new financial circumstances and today’s borrowing rates, the new interest rate may be higher. If you’re concerned about the interest rate you’ll qualify for, you can go through the prequalification process for a personal loan to get a realistic estimate.
It might pay more over time
Even if you do have a lower interest rate, if your monthly payments are stretched out for a longer period of time, then you end up paying more in interest. This is why running the numbers before you go through the loan is critical to ensure you’re saving money and not actually paying more with your new loan agreement. You can avoid this by paying off the loan early.
Your underlying money issues may not be resolved
Debt may come from a one-off experience, such as unplanned medical bills or an emergency, but sometimes our money habits lead us into it. If overspending or lack of a budget leads you to multiple debt payments, a debt consolidation loan can increase the risk of this happening again.
Is debt consolidation right for me?
Everyone’s financial situation is unique, so there’s no right or wrong answer here. Debt consolidation might be a wise choice if:
- You have a larger amount of debt: Is it small enough to pay it off within a year, or do you need several years at the current rate?
- Your credit score has increased: If you’ve improved your credit score since taking out your initial loans, you may qualify for a lower interest rate now.
- You have the cash flow now: Your budget now can comfortably make the singular payment, and you don’t have the potential risk of missing payments.
- You’ve made changes to your financial behavior: If you’ve evaluated your spending habits (such as overspending) and identified the root cause of the debt, then it may help you avoid this scenario in the future.
Millions struggle with debt. We help them move on with their lives.
- End your debt stress with a proven, affordable debt relief program. Our consultants will guide you through every step.
- Everyone’s financial situation is different. That’s why we start by giving you a free debt analysis and create a custom solution based on your unique needs and goals.
- Let us help you solve your debt problems and move forward with improving your overall financial health.
Not available in CO, HI, ND, OR, RI, VT, WA, WV, WY, MN, DE, IA.
FAQ
Does debt consolidation ruin your credit?
Debt consolidation can decrease your credit score by a few points initially due to the hard credit check the lenders use to view your credit history and score. However, this typically falls off within 24 months.
How long does debt consolidation stay on my credit report?
Your debt consolidation loan stays on your credit report for as long as it’s open. Your monthly payment activity is updated to the credit bureaus each month, and your payment history stays on your credit report for seven years.
Does debt consolidation go into your bank account?
Most of the time, lenders can pay your creditors directly based on the information you supply with your loan. You can request to have the lump sum deposited in your bank account alternatively, but this might not be possible with all lenders.
The bottom line
Debt consolidation is one tool available for debt management. If you’ve started a journey to become debt-free, then debt consolidation may be a tool to get you there sooner. However, if you think you’ll still struggle with overspending, then a debt consolidation loan could end up causing more harm than good.
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Writer
Sara Coleman is a former corporate gal turned creative entrepreneur. She began writing professionally several years ago and now contributes to multiple websites, blogs, and magazines. She’s also an avid reader and can’t resist a great historical fiction novel. Sara holds a BA in journalism from the University of Georgia and can be found supporting her Bulldogs every chance she has. She resides in Charlotte, North Carolina, with her wonderfully supportive husband and three children. When she’s not ushering her kids to sports and dance lessons, she can be found creating content for her own website, TheProperPen.com.
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