What is debt consolidation?
By Aaron Crowe
Reviewed by Kimberly Rotter
Jul 18, 2023
Read time: 5 min
Debt consolidation can make it easier to get rid of several debts by rolling them into one fixed monthly payment.
You don't have to own anything of value to borrow against to apply for a personal loan.
Home equity loans come with a longer repayment period, which can lower your monthly payment.
High interest and multiple bills to pay each month can cause even the most Zen person to lose sleep. Rising interest rates don’t help.
To reduce debt stress, you could try meditating. Or, you can make an action plan to simplify your finances and attack your debts. Debt consolidation can help you organize your finances and maybe even save some money.
What is debt consolidation?
Debt consolidation is when you combine multiple debts into a single new loan. Reducing the number of monthly payments you have to make can help you manage your finances and worry less about missing a payment.
How debt consolidation works
When you consolidate debts, you take out a new loan and use it to pay off other debts (or portions of other debts). Debt consolidation doesn’t erase your debt. It moves it to a new loan.
Most debt consolidation loans are fixed-rate installment loans. "Fixed-rate” means the interest rate never changes. “Installment” means the payment amount won’t change. You make the same payment every month until the loan is paid off. These features can give stability and predictability to your budget.
Types of debt consolidation
There are three basic ways to consolidate debts. A personal loan, a home equity loan, or a credit card balance transfer.
Consolidating debt with a personal loan
Most personal loans are unsecured loans, which means you qualify based on your creditworthiness and income. You can usually find loans between $5,000 and $50,000, but it’s also possible to find lenders that offer smaller or bigger loans. The interest rate you pay will depend on your credit profile and could be between 8.99% and 35.99%.
Most lenders charge a fee for making the loan. It’s called an origination fee and can run from 1.99% to 5.99%. It’s based on your credit profile and the amount you’re borrowing.
Personal loans are designed to be paid off within two to five years. If you use a personal loan to consolidate credit card debt, your monthly payment amount could be higher than what you’re paying now. Credit card minimum payments are very low—because they are designed to keep you in debt for a long time. You can look at your monthly credit card statement to find out how many years it would take to pay off your current balance by paying the minimum. A personal loan payment is calculated to completely pay off the loan by the end of the repayment period.
Home equity loan and debt consolidation
If you’re a homeowner, there are two ways to borrow against your home equity to pay off debt: a home equity loan or a home equity line of credit (HELOC). Home equity loans and HELOCs are secured loans. You pledge your home as a guarantee that you’ll repay the loan. If you don’t, you could lose your home. Because of this guarantee, some home equity loans are easier to qualify for compared to personal loans.
Home equity loans can be a good way to consolidate credit because they have fixed interest rates. That means your payment will be the same each month, which can make it easier to budget for.
Home equity loans also have a longer repayment term than personal loans, sometimes up to 20 years. This can lower the monthly payment and make it easier to repay, though you’ll likely pay more in interest.
HELOCs charge a fixed or variable interest rate. It’s a line of credit that can be used as needed during a draw period of a few years. With a variable rate, your payments could change and be higher than what you can afford. A fixed-rate HELOC can be cheaper and make more sense for debt consolidation.
Balance transfer as a way to consolidate debt
When you do a balance transfer, you are moving your credit card debt from one credit card account to another, usually because the new account offers a zero percent or very low-interest rate for a short time. The promotional interest rate typically lasts from 6 to 21 months. During this time, all or most of your payments will go toward lowering the amount that you owe. After the promotional period ends, any balance remaining on the account will be charged the regular interest rate, typically between 17% and 36%, but occasionally lower.
Balance transfers are rarely free. You’ll probably pay a fee equal to 3% to 5% of the amount that you transfer. If you transfer $5,000 and the fee is 4%, the balance on your new card will be $5,200.
Balance transfers seem like a great opportunity. Who wouldn’t want zero percent interest? But there’s a risk that not a lot of people talk about online. A very common pitfall is to pay off a credit card using a balance transfer and then make new charges on the paid-off card. It can happen before you realize it. Then you could have twice as much debt as you did before—and an even bigger hill to climb before you can get rid of your debt.
It’s a good idea to consider a balance transfer a one-time move that’s part of a larger overall strategy to reduce your debt. In fact, you could even close your credit card accounts after you transfer the balances if you really want to make sure that you don’t slip into using those old cards again while you’re focusing on paying off your debt. It’s true that closing credit card accounts can have a temporary negative impact on your credit. But if you’re making on-time payments every month and steadily reducing your debts, your credit score can recover. The important thing is to work on getting rid of debt.
Most credit cards start with a credit limit between $500 and $20,000.
Benefits of debt consolidation
There are several possible benefits of debt consolidation (and you don’t necessarily have to get all five to make it a worthwhile strategy):
Reduce the number of monthly bills you have to pay. Worry less about missing payments.
Lower your interest rate (it wouldn’t make sense to pay off a debt with a more expensive loan)
Lower your monthly payment (you could do this if you take longer to pay off the loan, lower the interest rate, or both)
Get rid of your debt faster than by making minimum payments
Potentially improve your credit standing (installment loans don’t affect your credit the same way credit cards do)
Alternative to debt consolidation
Loans and balance transfers aren’t the right answer for everyone. If you don’t qualify for a new credit account, or if you can no longer afford to repay your debts in full, you could consider resolving your debts instead.
Debt resolution is negotiating with your creditors to get a discount off your debt. You repay a portion of what you owe, and your creditor forgives the rest. Creditors may be willing to do this if they believe that you genuinely can’t afford to repay your debt in full.
Negotiating can be stressful, especially if your life is already complicated by financial hardship. Some people choose to hire a professional debt resolution company. If you do, a team of expert negotiators will work with your creditors on your behalf. Also, with a debt resolution program, you make one affordable monthly payment, which can be lower than the monthly minimums you are currently paying on your debts.
When balances are high and causing anxiety, it’s a great idea to explore ways to manage your finances in a way that’s easier and less stressful. Now that you have an idea of what some of your options are, get a free debt evaluation. A licensed loan consultant can help you determine what the best option is for you.
Aaron Crowe is an Achieve contributor. He is a freelance journalist who specializes in writing about personal finances. He has worked as a reporter and editor at newspapers and websites for his entire career.
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
Can I consolidate credit card debt with a personal loan?
Yes. Consolidating and paying off credit card debt is a popular reason for getting a personal loan.
Is it hard to get a debt consolidation loan?
To get a loan, you’ll need to meet the lender’s requirements. Each lender is different, but you can expect them to have a minimum credit score and a maximum DTI.
The minimum credit score for a personal loan is typically between 620 and 700. The minimum credit score for an Achieve fixed-rate HELOC is 600 if you let us directly pay off your other debts.
DTI stands for debt-to-income ratio, and it’s the percentage of your income that you spend on debts. The lenders look at this number to decide whether you can afford the new loan.
If you don’t qualify for a loan, you can consider a debt resolution program to get rid of your debts. Professional negotiators will work with your creditors to let you pay off your debts for less than the full amount you owe. You make a single, affordable monthly payment into a Dedicated Account. After the debt resolution company reaches an agreement with each creditor and you approve it, they use the money in this account to pay the negotiated amounts. There's no minimum credit score requirement to resolve debts.
Does consolidating hurt your credit?
When you apply for a loan, the lender checks your credit with a hard inquiry. This can have a temporary negative impact on your credit profile.
Making your loan payments on time can have a positive impact on your credit. Paying late and resolving debts for less than the full amount can have a negative impact.
Personal loans and home equity loans are installment loans. The balance doesn’t affect your credit the same way credit card balances do.
Having different kinds of credit accounts, like credit cards, a personal loan, and a home loan, can have a positive impact on your credit.