How does debt consolidation work?

By Rebecca Lake

Reviewed by Kimberly Rotter

Jul 30, 2023

Couple doing financial calculations in kitchen

Key takeaways:

  • Debt consolidation allows you to combine multiple debts to streamline monthly payments. 

  • Personal loans and home equity loans can be used to consolidate debts. 

  • Resolving debt might be a better option if you're struggling financially.

Nobody likes having a stack of bills to pay. And everybody wants to make good choices with their money. Under the right circumstances, a debt consolidation loan hits both of those targets.

Debt consolidation lets you roll up multiple debts into one. The three most common tools people use to consolidate debts are personal loans, home equity loans, and credit card balance transfers.

Consolidating debts can give you some financial breathing room, making it easier to pay back what you owe. But each debt consolidation option has pros and cons, and it’s not always obvious why you might want to choose one direction instead of another.

Here's a closer look at how debt consolidation works. 

What is debt consolidation?

Debt consolidation simply means combining multiple debts into one. You get a loan, then use the money to pay off your other debts. 

Going forward, you make one payment to the consolidation loan each month, according to the repayment terms set by the lender. 

Debt consolidation is associated with these three goals (but it’s normal for only one or two of them to be met):

  • Reduce the number of monthly payments you have to make

  • Lower your interest rate

  • Lower your monthly payment amount

What kinds of debts can you consolidate?

For the most part, debt consolidation is good for unsecured debts. Unsecured debt isn't attached to any collateral, which is something valuable that you pledge to the lender as a guarantee. 

Unsecured debts include: 

  • Credit card balances

  • Medical bills

  • Installment loans

You could put student loans here, too, but student debt consolidation works differently. You can consolidate federal student loans through the federal government. Many personal loan lenders, however, including Achieve, specifically prohibit using the loan funds for post-secondary school expenses or to refinance student debt. That’s because student loans are in their own legal category and have to be set up and managed in a different way.

Different ways to consolidate debt

If you're interested in consolidating debt, there are a few ways you might approach it. They include:

  • Using a personal loan

  • Borrowing against home equity

  • Applying for a balance transfer credit card

A personal loan for debt consolidation lets you borrow a lump sum of money that you can use to pay off debt. You'd pay back the loan to the lender with interest. 

Home equity loans are an option if you own a home and have built up enough equity to borrow against. Your equity is the difference between what you owe on the home and what it’s worth. The amount you can borrow depends on how much equity you have. 

Balance transfers let you move credit card balances from one card to another. Ideally, you get a 0% interest rate on the transferred balance for a set time. Balance transfers can be tempting, but there are some downsides.

For one thing, credit card companies usually charge a fee for them. And for another, there's always the risk that you might run up new balances on your cards after paying them off. That could leave you with even more debt to deal with. 

Here's a comparison of all three debt consolidation strategies and how they work. 

Personal loan

How it works: Personal loans let you borrow a certain amount of money to pay off debt. You pay the loan back to the lender with interest. Typically, you'll have anywhere from two to five years to pay it off. 

Collateral requirements: Most personal loans are unsecured, meaning you don’t have to own something valuable that you can offer the lender as a guarantee.  

How much can you borrow: Typically $5,000 to $50,000, but some lenders offer smaller loans.

Who it’s good for: Personal loans for debt consolidation might be good for someone whose credit is good enough to qualify. You'll also need to be committed to not running up new debt on freshly paid-off credit cards. 

How to apply: Apply here and talk to a loan consultant.

Read more: How to get a personal loan

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Home equity loan

How it works: Home equity loans let you borrow against your equity, which is the difference between your home's current market value and the amount you still owe, if any, on your mortgage. You could use the funds from a home equity loan to consolidate and pay off other debt, often for a lower monthly payment than your current monthly minimums. You'll typically have 10 to 30 years to pay ‌off the loan. Here at Achieve, we offer 10-year and 15-year terms, and we guarantee monthly savings if you are using the loan for debt consolidation. 

Collateral requirements: You pledge your home for the loan.

How much can you borrow: Typically $15,000 to $150,000, but some lenders offer bigger loans to those who qualify.

Who it’s good for: If you have enough equity and are comfortable with a longer repayment period, or if you have several debts that need to be paid off, then a home equity loan might work for you. 

How to apply: Apply here and talk to a mortgage advisor.

Read more: What it takes to get a home equity loan

Homeowners, get help with your high-interest debt

Use the equity in your home to consolidate debt, lower your monthly payments, and reduce your stress.

Balance transfer credit card

How it works: Balance transfers let you roll balances from one credit card to another, usually at a lower interest rate. You'll have anywhere from six to 21 months to pay the balance before the card's regular APR kicks in.

Collateral requirements: None

How much can you borrow: The credit limit is usually between $2,000 and $20,000, depending on your creditworthiness.

Who it’s good for: A balance transfer is only a good option if you know you can pay off the balance before the promotional rate ends and you've sworn off charging any new purchases to your cards. 

How to apply: First check your own credit cards that have available credit. Sometimes you can do a balance transfer without applying for a new card. Otherwise, research available balance transfer options and apply online directly with the card issuer. 

Seven steps to make debt consolidation work for you

Ready to consolidate your debts? Here's a simple checklist for the next steps. 

  1. Add up your debt. Before applying for a debt consolidation loan, you must know how much you owe. Also, take note of the interest rate for each debt on the list that you want to consolidate. It wouldn’t make financial sense to take a new loan with a higher rate.

  2. Choose a debt consolidation option. Once you know how much you need to borrow, you can decide which consolidation solution is right. If you owe a smaller debt, you might choose a personal loan. For larger amounts, a home equity loan might be best.

  3. Check the requirements. Lenders can set different guidelines for loan approval. For example, you might need a minimum credit score to get approved for personal loans or a minimum amount of equity to get a home equity loan. 

  4. Get a quote and apply. Rate quotes let you compare loan interest rates and terms before applying. When you shop for a loan, make sure the lenders you contact can do a soft credit check. Soft credit checks don’t have any effect on your credit. When it’s time to apply, they’ll do a hard credit check, which can have a small, temporary negative impact. 

  5. Review the loan offer. After approval for a debt consolidation loan, it’s a good idea to review the loan terms before signing off. Specifically, understand what interest rates and fees you'll pay, your monthly payment, and how many payments you'll make.

  6. Automate payments. Setting up automatic payments to your debt consolidation loan can help you avoid late payments and late fees. Your lender may even offer an interest rate discount for enrolling in autopay. 

  7. Don't add to your debt. Once you get debt consolidation loan funds, you can use them to pay off credit cards or other debts. However, you want to avoid the temptation to run up new balances on those cards once you pay them off. 

That last step might be the most important. If you're consolidating debts to reduce what you owe, creating new debt won’t help. Consider closing your credit card accounts after you pay off your balances with your consolidation loan.

Not everyone is at risk of running up credit card debt. Your debt may have resulted from a medical event, a job loss, a divorce, or other unforeseen circumstances. But if you are still improving your money management skills, you might want to take extra precautions to avoid worsening your situation. Give yourself a layer of protection by closing the cards (or keep one open for emergencies, but don’t use it).

It may feel scary to reduce your access to credit, but you’ll feel even worse if you run the balances back up. It can happen before you know it. 

Closing credit cards can have a temporary negative impact on your credit. But dealing with your debt can have a long-lasting positive effect on your life, your finances, and your credit profile.

Resolve debt instead

There's another option for paying off debt that doesn't require you to borrow anything. Debt resolution is a potential solution for those having difficulty with their finances and who can’t afford to repay their debts without some degree of debt forgiveness

Resolving debt means paying it off for less than your full balance owed. It's not the same thing as debt consolidation, and it’s not a loan. You can communicate with creditors yourself or let a professional debt resolution company represent you in the negotiations. Creditors are usually only open to negotiating if you can show ‌financial hardship.

What's the benefit of resolving debt? If you don't have to pay back the entire amount you owe, you could get rid of debt faster than just by making minimum monthly payments.  When you work with a debt resolution company, you make one affordable monthly payment, and they do all the heavy lifting regarding negotiating payoff amounts. To learn more, apply here and talk with a debt consultant.

Leave debt behind, so you can move forward

Get rid of your debt and free up your cash flow without a loan or great credit.

Explore your options for getting out of debt

Debt can stand in the way of achieving your financial goals, but consolidation can offer a way out. Looking at all the possibilities for getting rid of debts can help you find the right solution for your needs. Once you decide on a consolidation option, using a money management app is a good way to stay on top of your finances.

Rebecca Lake - Author

Rebecca is a senior contributing writer and debt expert. She's a Certified Educator in Personal Finance and a banking expert for Forbes Advisor. In addition to writing for online publications, Rebecca owns a personal finance website dedicated to teaching women how to take control of their money.

kim rotter 2022 2

Kimberly is Achieve’s senior editor. She is a financial counselor accredited by the Association for Financial Counseling & Planning Education®, and a mortgage expert for The Motley Fool. She owns and manages a 350-writer content agency.

Frequently asked questions

It's possible to consolidate different types of debt into a single loan. For example, you might use a personal or home equity loan to pay off credit cards, medical bills, installment loans, or other debts.

You can consolidate federal student loans through the Direct Consolidation Loan program offered by the Department of Education. You can sometimes consolidate private student loans through private student loan lenders. Remember that combining federal and private student debt is not recommended because you can lose certain federal protections, including forbearance periods and income-based repayment options.

You still have options if you can't qualify for a debt consolidation loan. Debt resolution is negotiating with your creditors to lower the amount you owe. Resolving debts can help you get rid of your debts faster than by making minimum payments. 

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