Affiliate links for the products on this page are from partners that compensate us (see our advertiser disclosure with our list of partners for more details). However, our opinions are our own. See how we rate personal loans to write unbiased product reviews.
- Debt consolidation involves paying off multiple debts with one large debt at a lower interest rate.
- You can consolidate debt using one of thebest debt consolidation loans.
- Consolidating debt will add a hard inquiry to your credit report and affect your credit utilization.
Introduction to debt consolidation
Having multiple debts, all at different interest rates with different payment dates, can be stressful and expensive. One payment that falls through the cracks and ends up on your credit report can hurt your credit score.
Instead of dealing with all these debts, it may be worth your time to consolidate your smaller debts into one large debt with a lower interest rate. This can save you money, but consolidating your debt isn't a decision you should take lightly.
Steps to consolidate debt
Assessing your debt
If you have a considerable number of debts, consider debt consolidation. However, while simplifying your debt may increase your quality of life, that sole reason shouldn't justify going through the consolidation process, especially when there are debt-tracking services that can help you manage your debts. Some of them are even free.
You should consolidate debt mainly to get a better interest rate. Unfortunately, it's hard to determine your APR on any credit consolidation products since many lenders only tell you what interest rate you qualify for once you apply. That said, your interest rates will be more favorable the higher your credit score is.
That said, the credit scoring algorithms give you a rate-shopping window when applying for loans. This means that you can apply to multiple loans within a short period of time, within 14 to 45 days, without triggering a hard inquiry on your credit report for each application. Instead, all those applications will be calculated as a single inquiry. This allows you to compare rates between lenders and find the best deal.
Additionally, balance transfercredit cards usually come with a 0% introductory APR period which generally lasts for 12 to 21 months, depending on the card.
Related: The best personal loans for bad credit»
Researching consolidation options
If you decide to move forward with debt consolidation, you'll have one of three options: a balance transfer credit card, consolidation loan, or home equity loan.
Choosing the right debt consolidation method
Balance transfer credit cards
Balance transfer cards offer another smart way to consolidate debt and save money on interest. These cards, also known as 0% APR cards, allow you to transfer your balances on other credit cards onto one card that usually comes with an introductory 0% APR which can last anywhere from 12 to 21 months. Read about our picks for the best balance transfer cards here.
You may have to pay a 3% or 5% balance transfer fee for the privilege, but the price can be well worth the interest you save. Also, note that some balance transfer cards don't charge fees if you transfer your balances within a specified amount of time.
Balance transfer cards are best for:
- Consumers who have the discipline to stop using credit cards after they transfer a balance
- Anyone willing to attack their debts with force during their card's introductory offer period
- People who have a smaller amount of debt they can pay off in 12 to 21 months
Consolidation loans
One of the best options for debt consolidation is a personal loan. These unsecured loans let you consolidate multiple debts into a new loan with a fixed interest rate, fixed monthly payment, and a fixed repayment period. This means you'll know exactly how much you owe each month and when your debts will be paid off.
You can shop for the best personal loan rateson marketplaces like SoFi. As mentioned earlier, you will have a rate-shopping window where all the hard inquiries that lenders pull within a certain period of your first application will be calculated into your credit score as one hard inquiry.
Most personal loans let you borrow up to $35,000, then repay it over three to five years (terms vary based on the lender you choose).
Personal loans are best for:
- Consumers who have a lot of debt to pay off over several years
- Anyone who wants a fixed interest rate, fixed payment, and fixed payoff date
- People who prefer to stop using credit while they pay down debt
See our picks for the best personal loans »
Home equity loans and lines of credit
It's also possible to consolidate your debt using ahome equity loan or home equity line of credit (HELOC). While these options come with lower interest rates than credit cards and some additional benefits such as noorigination feesor annual fees, these can be impractical and risky methods for debt consolidation. This is because you need a lot of equity in your home to qualify. Also note that you're putting your home up as collateral for these loans, meaning you risk foreclosure if you don't repay.
Navigating the debt consolidation process
Application and approval
Once you've made your choice, you need to apply for your chosen debt consolidation product. As you are essentially opening a new line of credit to pay off your other credit accounts, applying for these loans will trigger a hard inquiry on your credit report.
Managing consolidated debt
Once you get approved, you will need to manage your debt accordingly. Consolidation loans give you more structure in your repayment plan, but reaping the benefits of a balance transfer requires more discipline on your part. You will need to be aggressive with your credit card debt and try to pay off the entire balance within the introductory period.
Potential pitfalls and considerations
Understanding the risks
Depending on how your credit report looks, consolidating debt may affect your credit score in several ways.
The most apparent consequence of using a debt consolidation product is the hard inquiry it will add to your credit report. Consolidation loans and balance transfer credit cards, while serving a specific function, are still lines of credit that will result in a hard pull on your credit report. This will lower your credit score by a few points, provided you haven't opened any other lines of credit recently.
A balance transfer credit card also has the potential to affect your credit utilization ratio, the ratio between the credit you're using and your total available credit. Generally, you want to keep this under 30%, though every dollar into your credit limit counts against your credit score. The credit scoring algorithms such as FICO and VantageScore look at your credit utilization on revolving credit accounts overall and for each account.
Let's say you have three credit cards with the following balances and credit limits:
- Credit card 1: $2,000 out of a $4,000 limit.
- Credit card 2: $1,000 out of a $3,000 limit
- Credit card 3: $2,000 out of a $10,000 limit.
Your respective ratios would be 50%, 33%, and 20%, respectively, and an overall utilization ratio of 29.4%. Now you consolidate those debts onto a balance transfer card with a $10,000 limit. Now you have three cards with a 0% utilization ratio and one with a 50% utilization ratio. Additionally, your overall utilization ratio has dropped to 18.5%.
A consolidation loan's effect on your utilization ratio may shake out differently based on how much debt you have, how many credit cards you have, and the credit limit on your balance transfer card. Like your interest rates, your credit limit also varies based on your credit score.
Debt consolidation alternatives
There are other ways to get control of your debt aside from debt consolidation.
Debt settlement
Try a debt settlement plan if you simply have too much debt. This will take a heavy toll on your credit score, but you may emerge from the process with less debt. Unfortunately, there's no guarantee that your creditors will agree to a debt settlement.
If you're drowning in debt and consolidating it isn't an option, consider a debt settlement service. Working yourself out of a financial hole can be difficult, but you have opportunities to do so. Some options include:
Rework your budget
Oftentimes, there may be unexpected room in your budget to put toward your debt if you reallocate your spending to prioritize doing so. You may be able to cut down on discretionary expenses, or if that isn't an option, pick up a little extra work in the gig economy to get the extra cash you need. You can use any of the best budgeting apps to track your spending habits, find ways to spend less and save more, and budget effectively.
FAQs
Does debt consolidation affect credit scores?
Debt consolidation can affect your credit score due to credit inquiries. However, if managed well, it can improve your score over time.
Can I consolidate all types of debt?
You can consolidate most types of unsecured debts, like credit card debts and personal loans. Secured debts, such as mortgages, typically cannot be consolidated in the same way.
Are there fees associated with debt consolidation?
There are some fees associated with debt consolidation, especially when it comes to things like balance transfer credit cards and personal loans. Consider these costs when deciding if consolidation is cost-effective.
How do I choose the best method to consolidate my debt?
Choosing the best method to consolidate debt depends on your financial situation, the types of debt you have, your credit score, and your ability to make regular payments. Compare your options and seek advice from a financial advisor.
What should I avoid when consolidating debt?
When consolidating debt, avoid accruing additional debt, and understand the terms of your consolidation. Remember, consolidation is not a cure-all solution, so maintain financial discipline.
Freelance Writer
Holly Johnson is a credit card expert, award-winning writer, and mother of two who is obsessed with frugality, budgeting, and travel. In addition to serving as contributing editor for The Simple Dollar and writing for publications such as Bankrate, U.S. News and World Report Travel, and Travel Pulse, Johnson ownsClub Thriftyand is the co-author of "Zero Down Your Debt: Reclaim Your Income and Build a Life You’ll Love."
Senior Associate Editor at Personal Finance Insider
Paul Kim is a senior associate editor on Business Insider's personal finance team. He edits and writes about insurance. When he's not writing, Paul loves cooking and eating. He hates cilantro.
Top Offers From Our Partners
SoFi Checking and Savings Earn up to 4.60% APY on savings balances and up to a $300 bonus with qualifying direct deposit. FDIC Insured. There is no minimum direct deposit amount required to qualify for the 4.60% APY for savings. Members without direct deposit will earn up to 1.20% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Interest rates are variable and subject to change at any time. These rates are current as of 10/24/2023. There is no minimum balance requirement. Additional information can be found at http://www.sofi.com/legal/banking-rate-sheet. To earn the $300 bonus, the customer must complete a direct deposit with a minimum initial deposit of $250 in a new SoFi Checking and Savings account within 45 days of clicking to qualify (offer expires 12/31/24).
Editorial Note: Any opinions, analyses, reviews, or recommendations expressed in this article are the author’s alone, and have not been reviewed, approved, or otherwise endorsed by any card issuer. Read our editorial standards.
Please note: While the offers mentioned above are accurate at the time of publication, they're subject to change at any time and may have changed, or may no longer be available.
**Enrollment required.
Reference
