What is Debt Consolidation?

If you have several credit cards, personal loans, or other debts, a debt consolidation loan, home equity loan, or a credit card balance transfer with one monthly payment can help manage your debt and lower your overall monthly payment. It can be a good idea if you qualify for a lower interest rate. Combining multiple debts into a single loan can make it easier to manage, but there are a few risks to consider. It is crucial that you understand each loan option for debt consolidation before you act. Be aware of the pros and cons of debt consolidation and how to set goals to become debt-free.

Debt Consolidation vs. Debt Settlement

Debt consolidation combines debt into one loan or credit card. You keep the same amount of debt that’s combined into one payment usually with a lower interest rate. Debt settlement programs promise to settle your debts on your behalf. Because you’re trusting a third party to negotiate your debt, these programs pose a higher financial risk and should be avoided. While these programs claim they will work with your creditors to settle your debt for less than what you currently owe, they don’t always deliver as promised. If they fail to negotiate your debt, you’ll owe even more as late fees and interest accrue. These programs may also charge their own fees, and you may still get calls from debt collectors. Ultimately, debt settlement programs can damage your credit score and report, which can take years to recover.

Types of Debt Consolidation

The most common methods of debt consolidation include credit card balance transfers, home equity loans, and personal loans. Credit card balance transfers involve moving debt from one credit account to a credit card that usually offers a lower interest rate and 0% intro APR. While this may be a strategic move to reduce high-interest debt, pay attention to transfer fees and the promotional period where interest is not charged. Most cards are still compiling interest and will charge for all interest if the balance is not paid off by the end of the promotional period. Learn more in How Credit Card Balance Transfers Work.

Home equity loans are secured loans that allow you to use your home’s equity as collateral to borrow funds. Home equity is the difference between your home’s current value and the amount still owed on your mortgage. These loans offer lower interest rates than credit cards and the interest paid may be tax deductible.¹ However, using your home as collateral puts you at risk of foreclosure if you fall behind on payments. Learn more in Pros and Cons: Home Equity Loans for Debt Consolidation.  

Personal debt consolidation loans are unsecured loans, meaning you aren’t using a current asset like your home or car as collateral. While they often have a higher interest rate than home equity loans, you don’t have to worry about losing your home if you fall behind on payments. These loans usually offer lower interest rates than credit cards and make it easy to manage debt with one monthly payment. This method can also help you avoid the mistake of late fees and penalties when managing multiple lines of credit. You can also improve your credit score and report by consistently paying your monthly loan payments on time.

Set Goals to Become Debt-Free

Debt consolidation may be a strategic move if you are managing multiple high-interest debts and want to simplify your payments. However, if you aren’t changing spending habits that put you in debt to begin with, debt consolidation only postpones becoming debt-free. Set savings goals and reevaluate your spending habits to become debt-free faster. Learn more in Popular Strategies to Get out of Debt.

¹ Consult with your tax advisor.

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