Debt consolidation involves merging multiple debts into a single new loan. While this approach can be convenient, it’s most beneficial for borrowers who can secure a lower interest rate and better loan terms on the new loan.

However, obtaining a debt consolidation loan is not a quick fix for existing debt. It can either pave the way to financial freedom or lead to more debt and credit issues. Carefully weigh the pros and cons after assessing your financial habits, future goals, and current debt load.

You can consolidate nearly any type of consumer debt, including medical bills, personal loans, credit cards, and student loans. However, consolidation loans are not an immediate fix—you still have to pay them off, and terms can last up to seven years.

Consider the following pros and cons to determine if consolidation is practical for you.

Pros

  • Potentially lower interest rate
  • Ability to pay down your debt faster, depending on your term
  • Better organization of your debts

Cons

  • Typically requires good credit for a lower interest rate
  • Another credit check on your report
  • Upfront fees and costs

Debt consolidation is often an effective way to organize your current debt and simplify repayment. When used correctly, it offers several benefits that could save you money and help you manage your finances more effectively.

Taking out a debt consolidation loan can expedite your journey to becoming debt-free and potentially save you money on interest by allowing you to pay down the balance more quickly. This is particularly beneficial if you carry significant credit card debt from month to month.

Moreover, consolidation provides a more streamlined approach to credit repayment. Unlike credit cards, which lack a set repayment term, loans come with a fixed timeline, helping you to manage and eliminate your debt more effectively.

As of July 2024, the average credit card interest rate is 20.71 percent, while the average personal loan rate is 12.35 percent.

Interest rates will vary based on your credit score, loan amount, and term length. However, if you have average credit or better, you can likely secure a lower interest rate with a debt consolidation loan compared to your current credit card rate.

Borrowers with excellent credit typically receive the lender’s lowest rates, which are significantly lower than the average credit card interest rate.

When you consolidate all your debt, you eliminate the hassle of managing multiple due dates each month, as you only have one monthly payment to remember. Additionally, the payment amount remains consistent each month, allowing you to know exactly how much to set aside.

With a fixed repayment schedule, your payment and interest rate stay the same throughout the loan term, ensuring no unexpected fluctuations in your monthly debt payments. Most personal loan rates are fixed, so you’ll know exactly how much is due each month and when your final payment will be.

Conversely, if you only make minimum payments on a high-interest credit card, it could take years to pay off the balance in full.

A debt consolidation loan may initially lower your credit score by a few points due to the hard credit inquiry. However, over time, consolidation can improve your score.

Managing a single monthly payment for a consolidation loan can be easier than juggling multiple debts. Since payment history makes up 35 percent of your credit score, consistently making on-time payments should boost your score.

Moreover, if your consolidated debt includes credit cards and you keep those cards open, you’ll benefit from a better credit utilization ratio and a longer credit history. Amounts owed on revolving credit account for 30 percent of your score, and the length of your credit history accounts for 15 percent. Therefore, it’s beneficial to keep your paid-off cards open if possible.

Before committing to debt consolidation, it’s crucial to weigh these potential downsides. However, despite these considerations, debt consolidation may still be a viable option for you.

Consolidating debt doesn’t guarantee you won’t incur debt again, nor does it eliminate your existing debt or address underlying financial habits. If you have a history of living beyond your means, you might revert to old behaviors once you feel free of debt. To avoid this, create a realistic budget and adhere to it.

Additionally, start building an emergency fund to cover unexpected expenses. With an emergency fund in place, you can avoid relying on credit cards for financial surprises.

Some debt consolidation loans may entail various fees, such as:

  • Annual fees.
  • Balance transfer fees.
  • Closing costs.
  • Loan origination fees.

Before committing to a debt consolidation loan, inquire about all associated fees, including charges for late payments or early repayment. These fees can potentially amount to hundreds or even thousands of dollars depending on your lender. While these fees may still justify the consolidation, it’s important to factor them into your decision-making process regarding whether debt consolidation is suitable for your situation.

Your debt consolidation loan might carry a higher interest rate compared to what you currently pay on your debts. This can occur due to factors like your existing credit score; if it’s lower, lenders may view you as a higher risk, resulting in higher interest rates and lower borrowing limits.

Additionally, be cautious about extending your loan term. While lengthening the term can reduce your monthly payments, it may also lead to higher overall interest costs over time.

When contemplating debt consolidation, carefully balance your immediate financial needs with your long-term goals to determine the optimal solution or explore alternative debt consolidation options.

If you miss a monthly loan payment, you’ll probably incur a late payment fee. Moreover, if a payment is returned due to insufficient funds, some lenders may charge an additional fee for the returned payment. These fees can significantly raise the overall cost of borrowing.

Furthermore, late payments are typically reported to credit bureaus once they are 30 days overdue, potentially causing substantial damage to your credit score. This could make it more challenging to qualify for future loans and secure favorable interest rates.

Consider enrolling in your lender’s automatic payment program, if available, to minimize the risk of missing payments.

If you have multiple high-interest debts and a solid credit score, consolidating them might be a smart way to save money. Consider these factors and use a debt consolidation calculator to determine if it’s the right move for you:

  • Strong credit score: With a credit score of at least 670, you stand a better chance of securing a lower interest rate compared to what you currently pay, potentially reducing your overall costs.
  • Preference for fixed payments: If you prefer having a fixed interest rate, repayment term, and monthly payment, a debt consolidation loan could suit your needs well.
  • Simplified finances: Consolidating debts into one monthly payment can be appealing if you find it cumbersome to manage multiple payments.
  • Ability to afford repayments: Ensure you can comfortably afford the monthly payment for the debt consolidation loan. It’s crucial to avoid deeper debt cycles by committing only if you’re confident in your financial stability down the road.

Debt consolidation offers both advantages and disadvantages to consider:

On one hand, it allows you to consolidate multiple debt payments into a single monthly installment, potentially lowering your interest rates, improving your credit score, and accelerating the repayment of credit card balances. However, there may be fees associated with obtaining a consolidation loan, and securing a lower interest rate than your current debts is not guaranteed.

While debt consolidation can provide immediate relief, it doesn’t eliminate the underlying debt or address long-term financial issues. Before pursuing consolidation, it’s important to assess the reasons for accruing debt and identify any financial habits that may need adjustment.