Key takeaways

  1. Debt consolidation turns multiple debts into a single payment plan, making it easier to manage
  2. It involves taking out a loan to pay off several outstanding debts, potentially reducing the amount of interest you are paying and lowering your monthly payments
  3. It may be necessary to consider debt consolidation when the amount of debt and number of creditors become overwhelming
  4. Balance transfer credit cards and debt consolidation loans are two popular ways to consolidate debt, although there are other strategies such as personal loans or home equity loans available 
  5. Consolidating debt may initially decrease credit scores due to hard inquiries and new accounts, but can lead to improved credit if used correctly

Why consolidate debt?

Imagine you’re managing a team of athletes, each from a different sport – a basketball player, a soccer player, a tennis star, and so on. Every month, each player needs special attention, coaching, and training. Remembering their specific needs, schedules, and strategies can be overwhelming.

Now, think about how much simpler things would be if your entire team played the same sport. You’d have one game plan, one set of rules, and one strategy. 

That’s what debt consolidation does. It turns that mixed team of debts into a single “player,” making it much easier to manage. Instead of handling multiple debts with their own rules and timelines, you have one consolidated plan to follow. It’s a streamlined approach to tackling your financial game.

How does debt consolidation work?

Debt consolidation is the process of taking out a single loan to pay off several outstanding debts. Doing this can make it easier to pay back your creditors, as you will only have one payment to make each month instead of multiple. It can also reduce the amount of interest you are paying on those loans, as well as lower your monthly payments. 

When is it necessary to consider debt consolidation? 

When the amount of debt you owe and the number of creditors you have become overwhelming, and repayment feels unmanageable, it might be time to consider consolidating your debts. Debt consolidation can help simplify your payments and make them more manageable while also helping reduce the amount you owe overall. 

Debt consolidation risks

There are some risks associated with debt consolidation. Taking out a loan could mean that you end up paying more interest over the life of the loan than if you kept making payments on individual debts. Also, transferring multiple debts into one can be difficult and complex to manage. 

Debt consolidation do’s and don’ts


  • Educate yourself about debt consolidation - shop around for the best loan terms
  • Make sure to pay back your loan on time 


  • Consolidate debts without a plan to pay them off 
  • Skip payments on any of your outstanding debt 
  • Take out a consolidation loan with high interest rates or fees 

What are the best ways to consolidate my debt?

When it comes to consolidating debt, two widely used methods can help you manage your finances more effectively. 

  • Balance transfer credit cards
  • Debt consolidation loan

Balance transfer credit cards

Credit card balance transfers are a popular way to consolidate debt. Using this debt payoff method, you can open a new credit card account with a promotional APR offer. 

Low-to-no interest

Many credit card issuers offer qualified applicants a low or 0% APR on transferred balances for a limited time.

Balance transfer fees

Credit card issuers usually charge a balance transfer fee, typically 3% to 5% of the transferred amount. The card’s purchase APR applies to new purchases made with the credit card rather than the promotional rate.

After the promotional period, the card’s APR will return to the regular rate. Any remaining balance will be subject to the new rate.

Penalty rate

Late or missed payments usually result in a penalty rate applied to both the balance transfer amount and regular credit card purchases.

Debt consolidation loans

There are two types of debt consolidation loans: secured and unsecured loans. Secured loans are backed by an asset, like your home, which serves as collateral.

Unsecured loans are not asset-backed and can be harder to obtain. They often have higher interest rates and lower qualifying amounts. Nonetheless, both loan types generally offer lower rates compared to credit cards. The rates are typically fixed, ensuring they won’t increase during the repayment period.

Prioritize your debt payoff strategy by starting with the one with the highest interest and working your way down to the lowest.

Other debt consolidation strategies

Here are a few additional strategies people use to consolidate their debt. As always, consult a financial professional before employing any new methods.

Personal loans 

There are various types of personal loans, typically unsecured, meaning no collateral is required. They may have fixed or variable interest rates, but finding a lender offering fixed-rate personal loans is relatively easy.

Personal loans generally have lower interest rates compared to credit cards. Consolidating credit card debt with a fixed-rate personal loan can lead to savings over the loan’s duration. Additionally, personal loans have a fixed payment end date, unlike the revolving nature of credit cards.

Many online lenders offer personal loans with a simple application process. Use a loan comparison site to explore interest rates and loan terms you qualify for.

When you apply for a personal loan, the lender will perform a hard credit inquiry on your credit report, which can temporarily decrease your credit score. The lower score may be removed from your report in a few months.

If approved, the lender will send you the loan proceeds as a lump sum to pay off your other debts. You’ll then be responsible for making monthly payments on the personal loan.

Using a personal loan for debt consolidation may have drawbacks, including origination fees that increase your total repayment balance. Additional charges like late fees or prepayment penalties may also apply. Before signing the loan agreement, ensure you are aware of any associated costs.

Home equity loans

If you own a home with equity, you may consider a home equity loan. Equity is the home’s value minus the mortgage amount. For example, if your home is worth $500,000 and you owe $300,000 on the mortgage, you have $200,000 worth of equity.

Lenders also consider the loan-to-value (LTV) ratio when determining home equity loans. It represents the amount owed relative to the appraised value of the home. This percentage is calculated by dividing the appraised value by the remaining mortgage balance.

Lenders prefer applicants with an LTV of 80% or less. In the example above, the LTV is 40%.

$200,000 / $500,000 = 0.40 (40%)

You can usually access around 75% to 80% of your equity if you qualify.

Once the home equity loan is finalized, you will receive the total loan amount in a single payment. This lump sum can then be utilized to settle any outstanding debts you may have.

A home equity loan is like a second mortgage, using your home as collateral. Since defaulting on the loan could lead to losing your home, you should consider it carefully.

Does debt consolidation hurt credit scores?

Consolidating debts into a new loan can improve your credit scores in the long run, especially if used to pay off existing debt. However, initially, there may be a temporary decline in your credit scores. This is fine as long as you make timely payments and avoid accumulating additional debt.

Consolidation can lead to a temporary decrease in your credit score due to several factors. Here are some short-term causes to be aware of:

  • New credit applications - The first potential damage to your credit scores can occur before consolidation: When you apply for a personal loan or balance transfer credit card, the lender will conduct a hard inquiry on your credit, which can decrease your credit scores slightly.
  • New account - Opening a new credit account, like a credit card or personal loan, temporarily reduces your credit scores. Lenders view new credit as a potential risk, so your credit scores typically experience a temporary drop when obtaining a new loan.
  • Lower credit age - Your credit scores increase as your credit accounts age and demonstrate a positive payment history. However, opening a new account can temporarily lower your scores by reducing the average age of your accounts.

However, it’s not all negative. Let’s explore some of the benefits that debt consolidation can bring to your credit scores:

  • Lower credit utilization - The credit utilization ratio measures the amount of available credit you use. It may decrease when you open a new debt consolidation account since it increases your available credit. A lower credit utilization can help offset some of the negative impacts of opening a new account.
  • Better payment history - It won’t happen overnight, but making timely payments on your new loan can gradually improve your credit scores. Payment history significantly affects credit scores, so always strive to pay on time.

Final word

Debt consolidation can be an effective way to simplify multiple payments and save money in the long run. It may require some upfront effort and work to research lenders, compare interest rates, and apply for loans. However, the potential benefits of consolidating your debt can make it a worthwhile endeavor. 

Always do your due diligence before proceeding with any loan or financial commitment. As always, consult a financial expert before making any major financial decisions. 

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