Successful Debt Consolidation: Your Complete Guide

Debt consolidation is a common method of lowering debt payments. The wrong approach can cause more trouble, so learn how to consolidate debt the right way.
A couple at home look at their computer as they consider debt consolidation.
Written by:
Gina Freeman
Edited by:
Kristin Marino verified

Debt consolidation means replacing several debts with one account. Usually, you consolidate revolving accounts like credit cards, but you can also consolidate student loans or even secured debts like auto loans. Done correctly, debt consolidation won’t hurt your credit and could even help it.

Why Debt Consolidation?

People turn to debt consolidation strategies for several reasons. They usually want to achieve at least one of these goals:

  • Have fewer accounts and payments
  • Pay less interest
  • Get a fixed interest rate
  • Lower total monthly payments
  • Increase credit scores
  • Get debt-free faster

Your main goal can point you to the best strategy or product for your needs. Here are the best approaches for each purpose.

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Fewer accounts and payments

Usually, this is not a primary reason for debt consolidation, but it’s a happy bonus. If you’ve ever missed a payment because it slipped through the cracks, or if juggling multiple accounts causes stress, you can easily fix that by consolidating your accounts. Debt management plans (DMPs) from credit counseling firms, balance transfer credit cards, personal loans, and home equity loans can replace many monthly obligations with one payment.

Pay less interest

If the interest rates for your debts are on the high side, you may be able to reduce what you pay by consolidating your debt. If you consolidate debt with a personal loan, balance transfer credit card, or home equity loan, be sure that its interest rate is lower than that of the loans you’re consolidating. Don’t include an account in your consolidation if its interest rate is lower than that of the consolidation loan.

Get a fixed interest rate

Inflation has recently become a concern for consumers, and interest rates will rise as it takes hold. If you have accounts with variable interest rates, your rate and payment could climb. Currently, interest rates are low, and you might want to proactively consolidate your bills into one with a low, fixed interest rate. Personal loans and home equity financing both offer fixed rates. So do balance transfer cards as long as you clear your balance before the introductory period expires. Understand that your payment could increase with a personal loan or balance transfer because your repayment period is shorter.

Lower total monthly payments

Sometimes, you just need some breathing room, and lowering your total monthly payments takes precedence over paying the least amount of interest. In that case, debt management plans or home equity loans will probably reduce your monthly outgo the most. DMPs reduce your payment by working with your creditors to lower your interest rate, extend your repayment period or even reduce your balance. Home equity financing lowers your payment by getting you a better interest rate and extending your loan term to 15 or 30 years.

Increase credit scores

Debt consolidation can improve your credit score almost instantly. You can do this by reducing your “credit utilization ratio,” which makes up 30% of your credit score. Credit utilization is your total credit card balances divided by the total of your credit lines. If you have $10,000 in available credit, and your balances total $8,000, your credit utilization is 80%. That’s really high. But if you consolidate your credit card balances with an installment loan (like a personal loan or home equity loan), your utilization drops to zero. That can add 50 points or more to your score.

Get debt-free faster

If you make the minimum payments on your credit cards, it could take decades to repay your balances. And that’s assuming that you don’t keep charging. Credit cards make it very easy to spend and their tiny minimum payments make it easy to carry balances month after month. That makes credit card issuers a lot of money and keeps you in debt. A personal loan has a definite end date — five years is common — and you can’t keep adding to your balance. If you really want to get out of debt, you can consolidate your balances and pay them off over time. If you have a problem with overspending, it might make sense to close your cards or enlist the help of a credit counselor.

Debt Consolidation Strategies

You can choose from many systems to consolidate your debt. Each has its pluses and minuses and is better for some situations than others.

The most popular products are:

Some programs work better than others depending on your goal, amounts involved, and financial profile.

Debt management plan

Credit counseling agencies often offer DMPs in addition to debt counseling and budgeting help. Look for a reputable member of the National Foundation for Credit Counseling, the nation’s largest nonprofit financial counseling organization. The NFCC’s search tool helps you find local specialists for your financial situation. You also can call 800-388-2227 to be automatically connected to the NFCC member agency closest to you.

A credit counselor determines what you can afford to pay each month and works with your creditors to reduce your payments to a manageable level. That might include lowering your interest rate, waiving late charges, and even reducing your balances. DMPs only work if you can afford the payment. Their advantage is that you don’t need great credit to get one.

Balance transfer cards

Balance transfer cards allow you to pay off other credit cards by transferring their balances to a new card. If your credit is good, you might be offered an interest-free period of up to 24 months to clear your debts. You have to pay an upfront charge of about 3% for the privilege, but the interest savings can be substantial. This works best for smaller balances that you can clear before the introductory period expires.

You can also start with a balance transfer card and then use a personal loan to clear any remaining balance before the interest-free period ends.

Home equity financing

Home equity loans carry the lowest interest rates of any category of financing. That’s because they are mortgages, backed by your property. If you fail to repay the loan, the lender can foreclose and auction your home to get its money.

You can choose a home equity loan (also called a second mortgage), which comes with a fixed interest rate. Another option is a home equity line of credit (HELOC), which has lower setup costs but carries a variable interest rate. The last type of home equity financing is a cash-out refinance. If you plan to refinance your home to get better terms, you might be able to borrow extra and use that to consolidate your debts. Cash-out refinancing gets you the lowest interest rate but costs more to set up than the other options.

HELOCs are best for smaller amounts because they are cheap to set up. Home equity loans are better for larger amounts (tens of thousands), and cash-out refinancing is more appropriate for very large amounts. If you want to combine debt consolidation with, say, a home improvement loan, a cash-out refinance might be a good choice.

Home equity financing gets you the lowest payment and interest rate. However, extending your repayment for 15 or 30 years almost always costs you more interest over the life of the loan. If that’s a concern, you can accelerate your repayment and clear your balance in less time.

Personal loans

Personal loans are very popular for debt consolidation. They offer many advantages:

  • Lower setup costs than home equity financing
  • Very speedy processing because there are no assets to appraise
  • No collateral can be taken if you can’t repay the loan
  • Lower interest rates than comparable credit cards (on average, about 7% lower)
  • Fixed interest rates and payments
  • Loan amounts from $1,000 to $100,000
  • Terms ranging from one year to over 10 years

Many personal loan providers allow you to prequalify for financing without harming your credit score. You answer a few questions about your income, debts and estimated credit score and get offers with interest rates and loan terms. If you decide to go ahead, you’ll complete an application, supply documents to prove your income, and authorize a credit report.

The lender will either preapprove your loan quickly and then take a few days to verify your documents and fund your loan, or it will take a few days to grant your approval and then fund right away.

Debt Consolidation Mistakes to Avoid

Successful debt consolidation means avoiding these common mistakes.

Thinking that you’re debt-free when you’re not

When you see zero balances on your credit cards, it’s easy to forget that you still owe the money. It hasn’t been repaid, just transformed into a different form of debt. Until you clear your debt consolidation loan, you’re in debt. Budget accordingly and don’t run up your credit card balances again. Consumers who do end up worse off than before, with maxed-out credit cards, falling credit scores, and a debt consolidation to repay as well.

Failing to address underlying problems

Sometimes you get into debt because of a specific situation — your employer went out of business, you caught a catastrophic illness, or you had to help a family member through a financial emergency. In that case, find the cheapest and best way to repay that debt and move on. But if the reason for your debt is overspending, consolidating debt won’t address that. Failing to budget and get your spending under control will leave you worse off than before. If you find yourself repeating old patterns and carrying balances on your credit cards, you’re spending more than you earn. Reach out to a debt counseling service and get help.

Choosing the wrong solution

Some debt consolidation products may be wildly inappropriate for your situation. A personal loan may not lower your interest rate at all if you have poor credit. An installment loan even if its interest rate is low, might increase your monthly expense to unaffordable levels if the term is too short. Use an installment loan calculator to see if you can afford the monthly payment. And even a DMP might be unaffordable. Be realistic about what you can pay each month. Finally, understand that debt consolidation with a home equity loan might lower your payment a great deal but increase your costs overall. That’s not bad if the lower payment is necessary for your financial wellbeing. Just choose your debt consolidation with open eyes.