Debt Consolidation Explained
Debt consolidation combines multiple debts into a single loan with one monthly payment, ideally at a lower interest rate. This simplifies finances, potentially reduces monthly payments, and can save thousands in interest. Common consolidation methods include personal loans, balance transfer credit cards, home equity loans, or specialized debt consolidation loans.
Consolidation works best for high-interest debt like credit cards. If you're paying 18-25% on cards and can consolidate at 8-12% with a personal loan, the savings are substantial. For example, consolidating $35,000 of credit card debt at 18% into a 5-year loan at 10% saves over $20,000 in interest while cutting monthly payments by $200+.
However, consolidation only works if you address underlying spending habits. Many people consolidate debt, then accumulate new credit card balances, ending up with both the consolidation loan and new debt. Create a budget, cut unnecessary expenses, and commit to not accruing new debt. Consider closing credit cards if you lack spending discipline, though this may temporarily affect your credit score.
Quick Tips
- Always compare APR, not just interest rates
- Use the Rule of 72 to estimate doubling time
- Extra payments dramatically reduce total interest
Frequently Asked Questions
Credit cards, personal loans, medical bills, payday loans, and other unsecured debt. You generally can't consolidate secured debt like mortgages or car loans through personal consolidation loans.
Initially, yes - the hard inquiry and new account temporarily lower your score. However, making on-time payments and reducing credit utilization improve your score long-term, often resulting in a net positive.
Home equity loans offer low rates because your home is collateral. However, you risk foreclosure if you can't pay, and you're converting unsecured debt to secured debt. Only use if you're confident in repayment.
Cards offering 0% interest for 12-21 months on transferred balances. Good for consolidating credit card debt if you can pay it off during the promotional period. Watch for transfer fees (typically 3-5%).
No. Consolidation combines debts into a new loan you repay fully. Settlement involves negotiating to pay less than owed, which severely damages credit and may have tax consequences. Avoid debt settlement companies.