Complete guide to the pros and cons of debt consolidation
By Dori Zinn
Reviewed by Kimberly Rotter
Aug 22, 2023
Read time: 8 min
Debt consolidation combines multiple outstanding debts into one, and could make paying your bills easier.
Consolidating debt can lower your interest rate, monthly payment, or both.
You need to know the details about your current debts because a debt consolidation loan only makes sense if it improves your financial situation.
Juggling multiple bills each month and paying high interest rates? We feel you. Complicated, expensive finances can make it hard to get ahead of your debt. Debt consolidation is a powerful tool that can ease the pressure and make your debt more manageable.
What is debt consolidation?
Debt consolidation means combining multiple debts into one. You’ll then have one loan with a new interest rate and terms, and only one monthly payment to make.
You can use a debt consolidation loan to pay off any kind of debt, not just your credit cards. You can also pay off medical bills, student loans, car loans, other personal loans, private debt that you owe someone, or pretty much any other kind of debt.
Debt consolidation advantages
Here are some of the ways debt consolidation may improve your life. These might not all apply to your situation. Just consider the ones that matter to you.
Streamline finances. Replacing several debt accounts with one loan makes paying your bills easier. You'll have fewer accounts to track and fewer chances for things to fall through the cracks.
Preventing late or missing payments can help you build a healthy credit profile.
Reduce revolving debt. Using a personal loan to pay off credit cards or a home equity loan to pay off debt could have a positive impact on your credit profile. Loan balances don’t affect your credit the way high credit card balances can.
Credit utilization is how much credit card debt you owe, compared to your credit limits. Lowering your credit card balances can have a positive impact on your credit.
Lower your interest rate. You could reduce the total interest you pay if your consolidation loan has a lower rate than the accounts you pay off. (Credit cards tend to have higher interest rates than many types of debt consolidation loans.)
Paying less interest could free up money to pay down debt faster, buy things you need, or add to your savings.
Lower your monthly payment. If you're having trouble affording your monthly payments, you may be able to reduce them. You could get smaller payments by taking a loan with a lower interest rate or a longer repayment term.
Lower payments can give your budget some breathing room while you work on improving your finances.
Move variable-rate debt to a fixed rate. Many credit card accounts have variable interest rates. That means your payments can change, which makes budgeting harder. And when interest rates rise, it’s harder to afford debt payments. You can fix this by consolidating with a fixed-rate loan.
Fixed interest rates and stable monthly payments make budgeting easier.
Potential drawbacks to debt consolidation
Here are potential downsides to debt consolidation that you should watch out for.
Doesn’t reduce your debt. Debt consolidation does not wipe out your balances or lower the amount you owe.
A debt consolidation loan might not help if you have overwhelming debt.
Doesn’t fix spending problems. Debt consolidation doesn't fix poor budgeting habits or cure overspending.
If you run your balances back up after consolidating, you'll have those payments again, plus the payment on your consolidation loan.
Increases potential for more credit card debt. Paying off your credit cards with a loan frees up those cards for potential use. Adding to your credit card balances while you are paying a consolidation loan could be bad for your finances and your credit health.
Steadily paying down your debt over time can have a positive impact on your credit.
Loans have fees. Debt consolidation usually isn’t free. You might pay lender fees or balance transfer fees.
If the fees exceed the savings, consolidating debt may not be worth doing.
How to get a debt consolidation loan
Once you’re ready to explore your debt consolidation loan options, there are two ways you can go.
Personal loan for debt consolidation: pros and cons
Personal loan pros
The interest rate might be lower than the rate on the debts you want to consolidate.
Fewer bills to manage means you’re less likely to forget a due date.
You can usually get the money quickly—within a day or two after approval.
Fixed interest rates help you budget for predictable payments.
Pay off your debt faster compared to credit card minimum payments.
Personal loan cons
You might not qualify for a lower interest rate. Not everyone can save money with a consolidation loan.
The monthly payment may be higher compared to your credit cards.
Depending on how much debt you have, the maximum loan amount might not be high enough.
Home equity loan for debt consolidation: pros and cons
If you’re a homeowner with sufficient equity, you might be able to use a home equity loan or home equity line of credit (HELOC) to consolidate debt. This is a secured loan. You pledge your home to the lender as a guarantee that you’ll repay the loan. Borrowing against your home lowers the risk for the lender, so home equity loans tend to have lower interest rates than other kinds of loans.
Home equity loan pros
Usually has a lower interest rate compared to credit cards and other kinds of unsecured loans.
Home equity loans tend to have longer repayment terms, which can help you get a more affordable monthly payment and more breathing room in your budget.
Usually have a higher maximum loan amount compared to personal loans.
Home equity loan cons
Only available to homeowners with enough equity to borrow against.
A home equity loan is a mortgage. If, for some reason, you aren't able to repay the loan, you could lose your home.
The minimum loan amount might be more than what you need.
Other debt consolidation options
Here are a few other ways to consolidate debt.
Balance transfer credit cards. A balance transfer is when you move your outstanding credit card balance to a card with a 0% or very low APR promotional rate. The low rate usually lasts for 6 to 24 months. That can help you pay off your balance faster because your payments go toward the balance you owe, with little or none going to interest. After the promotional period ends, the rate goes up to the regular interest rate on the account.
Balance transfers might be an okay one-time solution, but they can be risky if you rely on them. There are two common pitfalls:
(1) Transfer the balance and continue to use the paid-off cards—so you keep running up debt.
(2) Juggling balances back and forth between balance transfer offers as each one expires is a recipe for financial wreckage. It’s easy for balances to increase or remain steady in this scenario. Juggling balance transfers takes a lot of effort. Each account is like a plate you’re spinning on a stick. Eventually, they all have to come down, whether that’s gracefully or with a big crash. Without a clear plan to avoid future debt, you’ll tire out and the plates will fall. It’s best to consider a balance transfer as a one-time solution that’s part of a well thought-out financial plan.
Pro tip: If you transfer a balance, close the paid-off account.
401(k) loans. A 401(k) loan is when you borrow from your retirement and then make payments back into the account, including interest. Not all employers offer this, and there are a couple of downsides.
First, by taking money out, you permanently reduce your ability to grow wealth over time in that account. Because of compound interest, time is the biggest advantage of retirement savings. You want to keep your money in the account for as long as possible.
Another risk is that if you separate from your employer for any reason, you might have to immediately repay the loan in full. If you can’t, the loan turns into a withdrawal. Then, depending on your age, you could be subject to income taxes and a 10% early withdrawal penalty fee.
DIY debt payoff. Put yourself on a tight budget and devote yourself to paying down debt as fast as you can. Tactics like the debt avalanche or debt snowball can help you speed things up.
Debt resolution. If you planned to repay your debt but can’t, debt resolution may be a path forward. Resolving debt means negotiating with your creditors (like medical providers or credit card companies) to accept an amount that's less than you owe, and forgive the rest. You can try this yourself or work with a reputable debt resolution service.
A professional debt consultant can help you choose the best option. Get a free debt evaluation today. It's good to know that there are many ways to fix a debt problem or to fine-tune your finances.
When is it a good idea to consider a debt consolidation loan?
You might want to look into a debt consolidation loan if:
You qualify. Many lenders offer pre-qualification. You can self-input credit and borrowing details online to learn whether you might be eligible for a loan. This isn’t a guarantee, but it’s a good indication of whether it makes sense to move forward with a full application.
You can afford the new payment. Use an online loan calculator to figure out what your monthly payment will be. If it’s too high for you, you might have more debt than you can afford. In that case, talk to a debt consultant about other options.
You want a clear payoff plan. By taking out a loan with a fixed interest rate and repayment terms, you’ll know exactly when you’ll pay off your debt.
You want to simplify your finances. By reducing multiple monthly payments to one, you’re making it easier to stick to a simplified financial plan.
You may want to skip debt consolidation if:
Your interest rate doesn’t drop. Lowering the cost of high-interest debt is a reason to consolidate your debts, and the reverse doesn’t make good financial sense. If you can’t qualify for a rate that’s lower than what you’re paying right now, it probably isn’t worth it to consolidate your debts.
You can’t afford payments. A fixed-rate loan with a set payoff date might have a higher monthly payment than what you’re currently paying on your credit cards. While that is likely to get you out of debt faster compared with making minimum payments, it also might mean you’ll have to pay more each month.
Dori Zinn is a personal finance journalist. Her work has been featured in the New York Times, the Wall Street Journal, Forbes, Yahoo!, and more.
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
How does debt consolidation work?
Debt consolidation means using one new loan to replace several accounts. Typically, debt consolidation involves taking out a home equity loan, balance transfer card, or personal loan with a lower interest rate and using the proceeds to pay off several credit cards with higher interest rates.
Can I still use debt consolidation if I have a low credit score?
Yes. If you qualify for a home equity loan and you’re borrowing to pay off other debts, you can apply with a 600 credit score.
Making on-time payments and chipping away at your balances will help you build healthy credit over time.
What types of debt can be consolidated?
Just about any kind of debt can be consolidated, including credit cards, medical bills, student loans, personal loans, car loans, and private debts.
Mortgages can be consolidated but because they tend to be bigger, this strategy has a different name. You'd normally want to look at a mortgage refinance loan, which is a new mortgage that pays off your old mortgage. If you don’t want to refinance your mortgage, a home equity loan might be a good option.
Is it better to consolidate or settle debt?
If you can’t afford to repay your debts, you might be a candidate for debt resolution. This is when you (or a professional debt resolution company that you hire) negotiate with your creditors to lower the total amount of debt you owe. Not all debt can be settled for less than the full amount that you owe. A debt consultant can help you figure out what path is right for you.
Can I consolidate student loans?
You can consolidate federal student loans through the US Department of Education for free. This combines your payments into one, which can make managing your loans easier. However, it won’t lower your interest rate. You can consolidate private student loans with a new private student loan. It’s not a good idea to pay off federal student loans with a private student loan because you’d lose certain benefits, like income-based repayment plans, that are only available if you have federal student loans.