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Debt consolidation rolls multiple debts, typically high-interest debt such as credit card bills, into a single payment. Debt consolidation might be a good idea for you if you can get a lower interest rate than you're currently paying. That will help you reduce your total debt and reorganize it so you can pay it off faster.
If you’re dealing with a manageable amount of debt and just want to reorganize multiple bills with different interest rates, payments and due dates, debt consolidation is a sound approach you can tackle on your own.
How to consolidate your debt
There are two primary ways to consolidate debt, both of which concentrate your debt payments into one monthly bill. The best option for you will depend on your credit score and profile, as well as your debt-to-income ratio.
Get a 0% interest, balance-transfer credit card: Transfer debt onto this card and then be sure to pay it off during the promotional period to get the interest-rate break. You will likely need good or excellent credit (690 or higher) to qualify.
Get a fixed-rate debt consolidation loan: Use the money from the loan to pay off your debt, then pay back the loan in installments over a set term. You can qualify for a loan if you have bad or fair credit (689 or below), but borrowers with higher scores will likely qualify for the lowest interest rates.
Two additional ways to consolidate debt are taking out a home equity loan or borrowing from your retirement savings with a 401(k) loan. However, these two options involve risk — to your home or your retirement.
Use the calculator below to see whether or not it makes sense for you to consolidate.
When debt consolidation is a smart move
Success with a consolidation strategy requires the following:
Your monthly debt payments (including your rent or mortgage) don’t exceed 50% of your monthly gross income.
Your credit is good enough to qualify for a credit card with a 0% interest period or low-interest debt consolidation loan.
Your cash flow consistently covers payments toward your debt.
If you choose a consolidation loan, you can pay it off within five years.
Here’s an example when consolidation makes sense: Say you have two or three credit cards with interest rates ranging from 11.21% to 25.7%, and your credit is good. You might qualify for an unsecured debt consolidation loan at 7.99% — a significantly lower interest rate. With less interest accruing each month, you'll make quicker progress toward being debt-free.
For many people, consolidation reveals a light at the end of the tunnel. If you take a loan with a three-year term, you know it will be paid off in three years — assuming you make your payments on time and manage your spending. Conversely, making minimum payments on credit cards could mean months or years before they’re paid off, all while accruing more interest than the initial principal.
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Consolidate your debt if you can get a better interest rate and/or it will help you make payments on time. Just make sure this consolidation is part of a larger plan to get out of debt and you don’t run up new balances on the cards you’ve consolidated. Read about how to tackle credit card debt.
How does a debt consolidation loan work?
A personal loan allows you to pay off your creditors yourself, or you can use a lender that sends money straight to your creditors. Read about the steps required to get a personal loan.
Do debt consolidation loans hurt your credit?
Debt consolidation can help your credit if you make on-time payments or if consolidating shrinks your credit card balances. Your credit may be hurt if you run up credit card balances again, close most or all of your remaining cards, or miss a payment on your debt consolidation loan. Learn more about how debt consolidation affects your credit score.
When debt consolidation isn't worth it
Consolidation isn’t a cure-all for all of your debt problems. You will still need to take steps such as seeking low-cost financial advice or lowering your living expenses. It’s also not the solution if you’re overwhelmed by debt and have no hope of paying it off even with reduced payments.
If your debt load is small — you can pay it off within six months to a year at your current pace — and you’d save only a negligible amount by consolidating, don’t bother. Instead, try a do-it-yourself debt payoff method instead, such as the debt snowball or debt avalanche. You can use a credit card payoff calculator to test out the different strategies.
If the total of your debts is more than half your income, and the calculator above reveals that debt consolidation is not your best option, you’re better off seeking debt relief than treading water.
» LEARN: What Canadians should consider about debt consolidation
Debt consolidation rolls multiple debts, typically high-interest debt such as credit card bills, into a single payment. Debt consolidation might be a good idea if you can get a lower interest rate than you're currently paying. That will help you reduce your total debt and reorganize it so you can pay it off faster.
The potential drawbacks of debt consolidation include the temptation to rack up new debt on credit cards that now have a $0 balance and the possibility of hurting your credit score with late payments. Also note that the best personal loans go to consumers with very good or excellent credit, so not everyone can qualify.
You might lose borrower benefits such as interest rate discounts, principal rebates, or some loan cancellation benefits associated with your current loans. Consolidating your current loans could cause you to lose credit for payments made toward IDR plan forgiveness or PSLF.
Debt consolidation is often the best way to organize your current debt and simplify repayment. Consolidation, if used correctly, offers benefits that could save you money.
Debt consolidation can negatively impact your credit score. Any debt consolidation method you use will have the creditor or lender pulling your credit score, leading to a hard inquiry on your credit report. This inquiry will decrease your credit score by a few points. However, this credit score decline is temporary.
You have to make sure you're making and maximizing your payments each month. Using a personal loan to pay off debt helps you get rid of multiple payments and go down to one payment per month — and hopefully with a much lower APR.
Here are some of the most common mistakes borrowers make when consolidating debt and how to avoid them: Locking in the first interest rate you're offered.Choosing the lowest monthly payment.Borrowing more money than you need.
Debt consolidation itself doesn't show up on your credit reports, but any new loans or credit card accounts you open to consolidate your debt will. Most accounts will show up for 10 years after you close them, and any missed payments will show up for seven years from the date you missed the payment.
You are then paying interest on that higher principal. May pay more over the life of the loan: Though consolidation can lower your monthly payment by, for example, extending your repayment term, that means you'll end up paying on your loans longer and ultimately paying more over time in interest.
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If a credit card account remains open after you've paid it off through debt consolidation, you can still use it. However, running up another balance could make it difficult to pay off your debt consolidation account.
Every lender sets its own guidelines when it comes to minimum credit score requirements for debt consolidation loans. However, it's likely lenders will require a minimum score between 580 and 680.
Debt consolidation might lower your monthly payments, make managing your monthly payments easier, decrease your interest rates and save you money overall. But there are also potential drawbacks, such as upfront fees and the risk of winding up deeper in debt.
Can I use debt consolidation without closing credit cards? Yes, although it depends on your situation. If you have good credit and a limited amount of debt, you probably won't need to close your existing accounts. You can use a balance transfer or even a debt consolidation loan without this restriction.
While there are no government debt relief grants, there is free money to pay other bills, which should lead to paying off debt because it frees up funds. The biggest grant the government offers may be housing vouchers for those who qualify.
Debt consolidation itself doesn't show up on your credit reports, but any new loans or credit card accounts you open to consolidate your debt will. Most accounts will show up for 10 years after you close them, and any missed payments will show up for seven years from the date you missed the payment.
Debt consolidation is almost always the better choice. And while it doesn't change how much you owe, you might save by getting a lower interest rate. However, you usually need at least good credit for this tactic to work. On the flipside, you could get some of your debt forgiven with debt settlement.
Consolidation does not automatically erase your debt, but it does provide some borrowers with the tools they need to pay back what they owe more effectively. The goal of consolidation is twofold. First, consolidation condenses multiple monthly payments, often owed to different lenders, into a single payment.
If you're struggling with multiple debts such as loans, credit cards and overdrafts, it may seem logical to consolidate them into one place – taking out a new loan to pay it all off, so you make one monthly payment instead. However it's often not that simple and can lead to even more debt.
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