Key takeaways:
- With debt consolidation, a borrower combines several types of debt into a single monthly payment.
- Two of the best ways to consolidate debt are with a personal loan or a balance transfer credit card.
- A debt consolidation loan may help borrowers streamline their finances, pay off their debt sooner, and improve their credit score.
There are many reasons a person can fall into debt—unexpected expenses, auto repairs, overspending, medical emergencies, or a job change. If you have debt, you may take comfort in the fact that you’re not alone: Many people struggle with debt. Although you have many options to repay what you owe, you may want to consider consolidating your debt.
Consolidating your debt with a personal loan, balance transfer credit card, home equity loan, or 401(k) loan can help a borrower combine several high-interest debts into one simple monthly bill.
When considering debt consolidation, review your financial situation along with the benefits and potential risks of debt consolidation before you make a decision.
What are the benefits of debt consolidation?
In certain financial situations, consolidating debt can provide a number of benefits. Some of these advantages include:
1. Simplified finances
With debt consolidation, you merge several debts into a single payment, which will lower the number of monthly debt payments you have. Additionally, because you’ll have a single fixed repayment schedule, you’ll have a better understanding of when the debt will be paid off. This can help you simplify budgeting and make payments on time.
2. A potentially lower interest rate
If your credit score has changed since you applied for your current loans or credit cards and you’re looking to consolidate your debt, consider shopping around for different lenders to see if you can qualify for a better interest rate. Shopping around and comparing lenders can help you figure out if you can get a low interest rate, which can save you a lot of money over the life of the loan. Interest rates vary depending on your credit score, the loan amount, and the length of the loan term.
However, you’re more likely to get a lower interest rate with a debt consolidation loan than what you may be currently paying for your credit card. To ensure you get a competitive interest rate, research different lending options, like a traditional lender, online lender, or lending platform, and try to prequalify when possible.
Pro tip: Not all types of lenders require borrowers to have a high credit score to qualify for a competitive debt consolidation loan. Some lending marketplaces, like Upstart, know that borrowers are more than their credit scores. Upstart’s model considers additional factors, such as a borrower’s education¹ and work experience, to help find them a loan with a rate they deserve.
3. You can pay off debt sooner
If you have a lot of high-interest credit card debt, consolidating your debt with a new loan may help you pay off your debt sooner. When you consolidate high-interest debts into a single consolidation loan, you are streamlining your finances into one, fixed monthly payment. In some cases, you may also qualify for a lower interest rate on the new debt consolidation loan.
By simplifying your bills and paying a lower amount in interest, you may be able to pay off your debt faster thanks to debt consolidation.That means you can focus on your other financial goals like starting an emergency fund or growing your retirement fund.
4. It may help improve your credit score
Does debt consolidation affect your credit score? When you consolidate your debt through a loan, line of credit, or a credit card, the lender may perform a hard credit inquiry. This may temporarily lower your credit score. However, consolidating debt can possibly improve your credit score in two ways.
- Consistent, on-time payments: Instead of juggling several monthly debt payments, you only need to worry about one monthly payment when you consolidate. This will help you avoid missing or making a late payment. By making consistent, on-time payments, you can improve your credit score.
- Improve your credit utilization ratio: If you consolidate debt with a revolving line of credit (like a credit card), you’ll increase your credit utilization ratio. This can also boost your credit score if you continue making on-time payments.
What are the risks of debt consolidation?
Debt consolidation can be a good way to organize your debt payoff, but there are some risks you need to consider.
1. You may need to pay fees
Depending on the debt consolidation method you choose, you may need to pay additional fees. Some of these fees may include:
- Origination fee
- Balance transfer fee
- Closing costs
- Annual fee
When you shop around for a new lender, ask them and your current lender about any fees they may charge so you understand the true cost before signing on the dotted line.
2. Your interest rate can rise
If your credit score is on the lower side, you may have a hard time qualifying for a competitive interest rate. In this case, you may qualify for an interest rate that’s higher than your current debt, which may cost you more over the life of the loan.
3. You may end up paying more in interest
Even if you qualify for a lower interest rate when you consolidate, you may end up paying more in interest over the new loan term. When you consolidate debt, the repayment term restarts. Although your monthly payment may be lower than the original, depending on the length of the loan, you may end up paying more in interest over the life of the new loan.
Pro tip: To get around this issue, adjust your budget so you can put more toward your monthly payments. This will help you get the benefits of debt consolidation without the added interest, as long as there’s no prepayment penalty.
Learn about more risks of debt consolidation today.
Debt consolidation FAQs
If you’re not sure whether debt consolidation is a good choice for you, read on to learn more.
When is debt consolidation a good idea?
Debt consolidation may be a good choice for you. It really depends on your commitment level and your unique financial situation. You may want to move forward with debt consolidation if:
- The combined total of your monthly debt payments isn’t more than half of your monthly gross income.
- You have a decent credit score, education, or work experience that can help you qualify for a debt consolidation loan, home equity loan, 401(k) loan or a balance transfer card with a competitive interest rate.
- You have enough cash flow to comfortably pay for your debt payments.
Pro tip: When researching your debt consolidation options, check your credit report to make sure you’re financially healthy. If you have a lower credit score or any outstanding payments, take time to resolve them before you apply for a debt consolidation loan.
Are debt consolidation loans a good idea?
Out of the most common debt consolidation methods, a fixed-rate debt consolidation loan can be one of the smartest options. If you qualify for competitive loan terms, you can consolidate your debt without having to pay a lot in interest or having to put up collateral. It’s important to note that the terms available to you will depend on your financial situation and the lender or lending platform you choose.
Some lenders require borrowers to have decent to excellent credit in order to qualify. However, some lending marketplaces, like Upstart, know that you’re more than your credit score. They consider other factors like your education and work experience when finding you a loan.
Is it a good idea to consolidate credit card debt?
Consolidating credit card debt into one payment can help you pay off your debt sooner. Many credit cards have high interest rates that make paying off your balance difficult. Using a personal loan or credit card consolidation loan to combine your card balances can help you pay off your debt quicker and save money in the long run.
Is consolidating debt a good idea?
Given the right circumstances, debt consolidation can be a smart financial move. However, in some cases, you may also need to address the underlying financial habits that contributed to your current debts.
Paying off several credit cards with a debt consolidation loan won’t help if you immediately take on new debt by running up the balances on your credit cards again.
Consider your lifestyle, financial habits, budget, and goals to determine if consolidating debt is the right move for you.
¹ Neither Upstart nor its bank partners have a minimum educational attainment requirement in order to be eligible for a loan.
Won't affect your credit score¹