Debt consolidation guide

When you’re juggling multiple bills and want a little breathing room, it’s natural to start looking for a simpler way forward. Debt consolidation is the combination of multiple debts into one, typically through a personal loan or home equity loan. 

With a consolidation loan, you use the loan proceeds to pay off credit cards, medical bills, and other debts, which leaves you with only the loan payment to make each month. Consolidation could be a solution for people who want to streamline their monthly payments and potentially save money on interest. 

But how does debt consolidation work exactly? Who is it right for? And how does it compare to other forms of debt relief? Those are all valid questions to ask if you're searching for a way to manage your debt situation. 

This debt consolidation guide offers an in-depth look at what it means to consolidate debt and the types of loans you could use to do it. We also cover the pros and cons of debt consolidation and some of the alternatives you might consider. By the end of this guide, you could be equipped with all the knowledge you need to make a confident decision about whether debt consolidation is right for you. 

What is debt consolidation?

You may hear debt consolidation talked about in the same conversation as debt settlement or bankruptcy, but the three strategies aren’t identical. Here's a quick look at the difference between them. 

• Debt consolidation is a financial strategy that involves combining multiple debts into one, usually through a loan. 

• Debt settlement is when you negotiate with creditors to get them to accept less than what you owe. If they agree, the rest of your debt is forgiven. 

• Bankruptcy is a legal process for discharging debts in full (Chapter 7) or restructuring your payments (Chapter 13). 

What is debt consolidation intended to do for you? In simple terms, it's meant to make repaying what you owe easier and less stressful. 

When you consolidate debt, you're making a conscious decision to borrow money to pay off your existing debts. You could zero out credit card balances, loan balances, and medical bills in one go and have just one debt payment to focus on going forward. 

Consolidation is most effective when you can get a lower interest rate on your consolidation loan than you're paying on your current debts. A lower rate could reduce your monthly payment and help you get out of debt faster.

Debt consolidation could bring relief if you're in the midst of a financial hardship or if you've been wanting to tackle your debt for a while but aren't sure where to start. Now that you've got the basics down, let's look at how debt consolidation works.

How debt consolidation works

Debt consolidation isn't a complicated process, and it's something most anyone can do if they qualify for a loan. Here's how debt consolidation works, step by step.

• Decide what type of loan to use. More than one kind of loan can work to consolidate debt. You'll have to decide what makes the most sense for you. We'll cover different types of debt consolidation loans in the next section of this guide. 

• Choose a lender. Once you settle on a loan type, the next step is choosing a lender. In this step, you'll compare debt consolidation loan rates, terms, and fees to find the best fit. You may want to prequalify to get a realistic idea of your potential loan options.

• Apply. Most lenders offer an online application process for consolidation loans. You'll need to tell the lender some details about your debt and consent to a credit check. Some lenders offer instant or same-day approval.

• Review the terms. If approved for a debt consolidation loan, check the terms before you sign any paperwork. Make sure you understand how much you'll borrow, what you'll pay in interest, and how long it will take you to pay off the loan. 

• Sign and get funded. If you're okay with the loan terms, you can sign the loan agreement and arrange for the lender to deposit the funds to your bank account. Lenders may offer next-day funding or take a few business days to get the money to you.

• Pay off your debts. Once the loan funds hit your bank account you can use the money to pay off credit cards and other debts. Some lenders offer direct payoff, which means they pay your creditors for you. 

• Repay the loan. After your other debts are paid, all you have left to do is repay your consolidation loan. You'll make one payment for the number of months specified in your loan agreement, until the balance is paid off. 

To make this all work, you have to commit to not running up a balance on your credit cards or adding to your debt in any other way. If you consolidate debt and then take on more high-interest debt, you're working against yourself. 

Types of debt consolidation loans

What is a debt consolidation loan? It's any loan that you take out to consolidate debt. There are two main types of debt consolidation loans used most often: 

• Personal loans. A personal loan is money you borrow for personal reasons. Most personal loans are unsecured and aren't tied to any collateral or security, which is something of value that you own that backs up the loan. You might be able to borrow anywhere from $5,000 to $50,000 with a personal loan for debt consolidation. 

• Home equity loans/HELOCs. A home equity loan or HELOC is a loan that's secured by your home; it's often called a second mortgage. When you get a home equity loan for debt consolidation, you're leveraging your home equity to borrow the money to consolidate. Equity is the difference between what you owe on your home and what it's worth. How much you can borrow with a home equity loan will generally depend on how much equity you have.

You might find debt consolidation loans go by other names. For example, lenders might market them as bill consolidation loans. But really, it all means the same thing. Consolidation loans, whether they're secured or unsecured, let you combine multiple debts into a single financial obligation. 

Is it better to use a secured or unsecured loan for debt consolidation? 

Secured loans could offer lower interest rates, since they're backed by collateral. You may be able to borrow more with a secured loan if you have a lot of equity built up. However, when you use a secured loan to pay off credit cards or medical bills, you turn those bills into secured debts. 

That could be risky if you can't repay your consolidation loan. Why? Because a home equity loan is tied to your home. If you can't repay the loan you risk losing the home to foreclosure. 

The most common type of unsecured debt consolidation loan is a personal loan. Since they're not backed by anything, unsecured loans tend to have higher interest rates than secured loans.

Another type of unsecured credit sometimes used to consolidate are balance transfer credit cards. A balance transfer moves your credit card debt from one card to another. This could save you money on interest if the new card has an active 0% APR offer. 

Depending on the offer, you may have anywhere from six to 21 months to pay off the balance before the regular (higher) APR kicks in. Whatever balance is left will start accruing interest at the new APR. The catch to these cards is twofold. First, you usually have to pay a balance transfer fee of 3% to 5% of the transferred amount. You also typically need good credit to qualify for a 0% APR offer.

Pros and cons of debt consolidation

Debt consolidation could work better for some people than others. Let's look at the pros and cons of debt consolidation to help you understand how it could help you and where it may fall short. 

The biggest pro of all may be the feeling that goes along with tackling your debt once and for all. Debt can make you feel helpless, but you're not—you just need a workable solution to pay down what you owe. 

A debt consolidation loan calculator can help you estimate what a new loan might cost and what your monthly payments could be. You can compare those numbers to the amount you’d pay if you stick to your current repayment plan to figure out which one yields the most savings. 

Is debt consolidation right for you?

When is debt consolidation a good idea? It could make sense if you:

• Have calculated your monthly payments with a consolidation loan and know you can afford them for the entire loan term.

• Want to simplify debt repayment and trim unnecessary payments from your budget. 

• Can qualify for a lower interest rate or a loan term that would allow you to pay off your debt faster. 

In terms of how to qualify for debt consolidation, lenders generally look at your credit scores, income, and debt. If you're interested in a home equity loan, your lender will also need to know how much your home is worth. They'll schedule an appraisal, either in-person or remotely, once you apply for a loan. 

Now, when should you reconsider? Debt consolidation may not be the best choice if you: 

• Have unpredictable income

• Can't meet the minimum credit score requirements for debt consolidation 

• Have a serious financial hardship that's already put you behind on payments

If debt collectors are calling, then you might be better off talking to a debt expert about settlement or a licensed attorney about bankruptcy instead. Either one could offer a path forward so you can get back on track financially. 

Special situations

Debt consolidation is personal, and your life circumstances should influence how you approach it. Here are a few scenarios to consider that could affect your options for debt consolidation and whether it's right for you. 

1. Bad credit

Bad credit isn't an automatic block to consolidation, but you may need to work a little harder to find the right lender. A debt consolidation loan for bad credit may have:

• Higher interest rates

• Lower borrowing limits

• Additional or higher fees

If you don't need to consolidate debt right away, you could focus on improving your credit scores. You could do that by paying bills on time, making extra payments to debt to reduce what you owe, and holding off on applying for new loans if you don't need them. 

2. Veterans and military

Debt consolidation for veterans could help you pay off high-interest debts and feel more in control of your finances. There's no government program that helps veterans consolidate credit card debt, but you could use a home equity loan, personal loan, or balance transfer to combine balances. You could also apply for a VA cash-out refinance loan if you have a mortgage through the Department of Veterans Affairs. 

Consolidation could give you more time to pay off your debts, potentially reduce your interest rate, and help you feel better about your financial situation. If you have medical debt that's related to your service, you can talk to the VA Debt Management Center for help with those bills. You might also look into your benefits under the Servicemembers Civil Relief Act (SCRA) if you need help managing mortgage payments. 

3. Without a loan

Can you consolidate your debt without a loan? Not exactly, but there are a few strategies for taking control of your debt that don't involve a new loan. Your options could include:

• Debt management plan (DMP). A DMP is a structured plan to repay debt that you create with the help of a credit counselor. You make one payment to your credit counselor each month, which is then distributed to your creditors. It's not a loan, and it could help you pay your debt off in three to five years.

• Debt settlement. When you enroll your unsecured debt in a debt settlement program, you make one monthly payment into a secure account that you own and control. A professional debt expert negotiates with your creditors on your behalf. Once they receive a settlement offer from your creditor, and you approve that offer, the money you’ve accumulated in your secure account is used to pay the agreed amount, often for less than what you originally owed.

• Debt snowball/avalanche. The debt snowball and debt avalanche are DIY methods to repay debt. With the snowball, you pay off debts from the lowest balance to highest, throwing as much money as you can to the smallest debt first. With the avalanche, you do the same, only you target the highest interest debt first. 

Your monthly budget, the amount you owe, and the type of debt you have can help you decide which option may work best. 

4. Guaranteed approval

Guaranteed approval debt consolidation means that credit usually isn't the main requirement to qualify. Guaranteed approval loans, sometimes called no credit check loans, could put money in your hands quickly but they often come at a high cost. 

Lenders use your credit scores to gauge your risk level. A higher credit score means lower risk, which translates to a lower interest rate. When there's no credit check (and no credit score to go on) the lender typically charges higher interest rates to offset the risk. That could make a guaranteed approval loan a very expensive option. 

Debt consolidation alternatives

A consolidation loan may not be right for you, but debt consolidation alternatives could be. We've already mentioned those alternatives throughout this guide but here's a refresher of how they compare. 

What's next

Debt consolidation could offer a light at the end of the tunnel and help you get on the right path to financial wellness. If you think consolidation would work well for your situation, the next step is finding a lender to work with. Find out if you qualify for a debt consolidation loan from Achieve.