Running a financial life with multiple sources of debt can feel like a juggling act where the balls are made of glass. It is completely normal to feel overwhelmed when you have different payments due on different days, all with different rules. We want to validate that feeling and help you find a path forward that brings a sense of calm and control back to your financial journey.
Why consolidate debt?
Picture this. You're managing a team of athletes where everyone plays a different sport. You have a basketball player, a soccer player, a tennis star, and so on. Every single month, each of these players needs special coaching, unique attention, and specific training. Trying to remember their individual schedules, needs, and strategies can quickly become overwhelming.
Now, think about how much simpler things would be if your entire team played the same sport. You would have one game plan, one set of rules, and a single strategy.
That is exactly what debt consolidation does for your money. 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 timelines, you have one consolidated roadmap to follow. It's a streamlined approach to tackling your financial game.
How debt consolidation works
At its core, debt consolidation is the process of taking out a single loan to pay off several outstanding debts. Doing this can make it much easier to pay back your creditors because 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 to consider consolidation
It might be time to consider consolidating your debts when the amount of debt you owe and the number of creditors you have become overwhelming. If repayment feels unmanageable, this strategy can help simplify your payments. It makes them more manageable while also helping reduce the overall amount you owe.
Knowing the risks
We believe in total transparency, so it's important to know the 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
Do:
- Educate yourself about debt consolidation and shop around for the best loan terms.
- Make sure to pay back your loan on time.
Don't:
- Consolidate debts without a clear roadmap to pay them off.
- Skip payments on any of your outstanding debt.
- Take out a consolidation loan with high interest rates or fees.
Strategies: Balance transfers and loans
When it comes to consolidating debt, two widely used methods can help you manage your finances more effectively.
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 ends, the card's APR will return to the regular rate. Any remaining balance will be subject to the new rate. Also, be aware that 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.
We recommend you prioritize your debt payoff strategy by starting with the one with the highest interest and working your way down to the lowest.
Other consolidation methods
Here are a few additional strategies people use to consolidate their debt. As always, we suggest consulting 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. You can 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. Be aware that 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. Lenders prefer applicants with an LTV of 80% or less. In the example above, the calculation looks like this:
$300,000 / $600,000 = 0.60 (60%)
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 this hurt my credit score?
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.
Temporary negative impacts
- 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.
Potential benefits to your score
- 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.
The Facet difference
At Facet, we believe your financial roadmap should be as unique as you are. While debt consolidation is a tactical tool, we look at your entire financial life - from retirement to family planning - to ensure every decision supports your broader goals. Our flat-fee membership model means we don't make money by selling you loans or products. We're here to offer objective advice that helps you achieve self-fulfillment and live well today, not just in the future.
