What is Debt Consolidation? | Bank rate

Even if you work hard to manage your money properly, paying back high-yield debt monthly can make achieving your financial goals difficult. No matter how much you owe, it can take months or even years to get rid of debt.

One way to deal with multiple debt payments is through consolidation. Debt consolidation is a form of money management that involves paying off existing debts by taking out a new loan, usually through a debt consolidation loan, a credit transfer credit card, a student loan refinance, a home loan, or a HELOC. Here’s what you need to know about debt consolidation and which method is best for you.

Definition of Debt Consolidation

Debt consolidation is the process of merging multiple debts into a single debt. Instead of making separate payments to multiple credit card issuers or lenders each month, bundle them into one payment from a single lender, ideally at a lower interest rate.

You can use debt consolidation to consolidate different types of debt including:

While debt consolidation won’t wipe your credit, the strategy can make debt settlement easier and cheaper. Getting a low interest rate can save you hundreds or even thousands of dollars in interest. Managing a payment can also make it easier to keep track of your bills and avoid late payments that can affect your creditworthiness.

Types of Debt Consolidation

No matter what type of debt you are consolidating, when you are looking for a debt consolidation method, you have several options to choose from.

Debt Consolidation Loans

Debt consolidation loans are personal loans that combine multiple loans into one fixed monthly payment. Debt consolidation loans typically have terms of between one and 10 years, and many allow you to consolidate up to $ 50,000.

This option only makes sense if the interest rate on your new loan is lower than the interest rate on your previous loans.

Best for: Borrowers who want a fixed repayment schedule.

Credit transfer credit card

If you have multiple credit card debt, a credit transfer credit card can help you pay off your debt and minimize your interest rate. As with a debt consolidation loan, a credit card with balance transfer transfers multiple streams of high-yield credit card debt to a credit card with a lower interest rate.

Most credit transfer credit cards offer an introductory period of 0 percent APR, which typically lasts between 12 and 21 months. If you can manage to pay off all or most of your debts during the introductory period, you could potentially save thousands of dollars in interest payments.

However, if you have a large balance outstanding after the period is up, you may end up in more debt because transfer credit cards tend to have higher interest rates than other forms of debt consolidation.

Best for: Borrowers Who Can Afford to Pay Off Credit Cards Quickly.

Refinancing the student loan

If you have high interest student loans, refinancing your student loan can help you get a lower interest rate. Student loan refinancing enables borrowers to consolidate both government and private student loans under one fixed monthly payment and better terms.

While refinancing can be a great way to consolidate your student loans, you still need to meet the eligibility requirements. Also, if you refinance federal student loans, you lose federal protection and benefits such as income-based repayment and deferral options.

Best for: Borrowers with high-interest private student loans.

Home loan

A home equity loan – often referred to as a second mortgage – lets you take advantage of your home’s equity. Most home loans have repayment terms of between five and 30 years, and you can typically borrow up to 85 percent of the value of your home minus any outstanding mortgage balances.

Home loans usually have lower interest rates than credit cards and personal loans because they are backed by your home. The downside is that if you disagree with the loan, your home is at risk of foreclosure.

Best for: Borrowers with a lot of equity in their home and a stable income.

Home equity line of credit

A home equity line of credit (HELOC) is a home equity loan that acts as a revolving line of credit. As with a credit card, a HELOC allows you to withdraw money at a floating rate if necessary. A HELOC also draws on your home’s existing equity, so the amount you can borrow depends on the equity you have in your home.

A HELOC is a long-term loan with an average draw period – the period in which you can withdraw funds – 10 years. The repayment period can be up to 20 years, during which time you can no longer borrow from your credit line.

Best for: Home borrowers who want a long repayment period.

How to Consolidate Your Debt

When trying to figure out how to consolidate debt, the process is pretty similar no matter what form of debt consolidation you are using. It is important to understand that debt consolidation is different from debt settlement. In debt consolidation, you use the funds from your new debt consolidation loan to pay off all of your existing debts in full.

Once you have received the funds from your personal loan, home equity loan, or any other debt consolidation loan, you can begin debt consolidation. Use these funds to pay off all of your existing debts. Then you only have one monthly loan payment, usually at a lower interest rate than all the interest rates on your previous loans.

Pros and Cons of Debt Consolidation

Debt Consolidation Isn’t the Right Choice for Everyone; Before you consolidate your debt, think about the pros and cons.


  • Pay less total interest. If you can combine multiple double-digit debt into a single loan with an interest rate of less than 10 percent, you could save hundreds of dollars on your loan.
  • Simplify the debt repayment process. It can be difficult to keep track of multiple credit card or loan payments each month, especially if they are due on different dates. Taking out a debt consolidation loan makes it easier to plan your month and keep track of payments.
  • Improve your credit score. You could see an increase in creditworthiness as you consolidate your debt. Paying off credit cards with a debt consolidation loan could reduce your credit utilization and your payment history could improve if a debt consolidation loan helps you make more timely payments.


  • Pay costs in advance. Any form of debt consolidation can come with fees, including opening fees, balance transfer fees, or closing costs. You should weigh these fees against potential savings before applying.
  • Jeopardize collateral. If you are using any type of secured loan to cover your debts, such as:
  • Could increase the total cost of the debt. Your savings potential on a debt consolidation loan depends largely on how your loan is structured. If you have a similar interest rate but choose a longer repayment period, for example, you will end up paying more interest over time.

When Debt Consolidation is a Right Decision

Debt consolidation works best when most of the debts you owe came from a previous situation that no longer applies to your life. Examples could be previous medical debts, student loans, or debts that you accumulated before getting to grips with your life.

In this case, debt consolidation can make a lot of sense. You can combine existing debts, which are often associated with high interest rates, into one monthly payment. You may also be able to qualify for a lower interest rate, especially if you are using a secured loan such as a home loan or home line of credit.

When You Shouldn’t Consider Debt Consolidation

Consolidating debt can help you save money on interest and repay your debt faster, but it doesn’t fix the underlying reason you were in debt. Before consolidating, examine the internal and external factors that created your current situation.

It is possible to consolidate debt if you have gone through debt consolidation beforehand, but it is not ideal. Debt consolidation works much better once you have fixed the underlying reason you got into debt in the first place. If you make sure these causes are addressed, your debt consolidation will become a successful experience for you.

The central theses

If you are interested in debt consolidation, make sure you have considered the underlying reasons behind your borrowing. When you are in a more stable place but have debts from earlier in life, debt consolidation can make a lot of sense. Take the time to review all of your options and seek quotes from multiple lenders, including credit unions, online banks, and other lenders. Compare interest rates, fees and terms before making your decision.

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