Pros and Cons of Debt Consolidation

Benefits of Debt Consolidation

In the right situation, debt consolidation comes with a host of advantages for your financial health. Here's how consolidating debt can help you.

You'll Have Fewer Bills to Manage

Consolidation can make managing your household budget easier by reducing the number of accounts you'll need to track and pay each month.

Even if your total balance, interest rate and monthly payment amount stay the same, freeing up your time and mental energy by just making one payment each month could be reason enough to look into debt consolidation.

You Could Save Money if You Qualify for a Lower Interest Rate

If your credit is in good shape, you could qualify for a consolidation loan with a lower interest rate, reducing your total interest costs and also potentially lowering your monthly payment.

You could also look into balance transfer credit cards, which offer a low or even 0% introductory annual percentage rate (APR) for a period ranging from 12 to 21 months. If you can manage to pay off the debt before the promotional period ends, you can eliminate interest charges entirely.

You Can Bring Past-Due Accounts Current

If you have accounts that are past due or in collections, using a debt consolidation loan to pay them off might help your credit score in a couple of ways.

For starters, the longer an account goes unpaid, the more damage it does to your credit score, so paying off your past-due debts can stop the bleeding, so to speak. Second, some newer credit scoring models don't include collection accounts that have been paid in full, so consolidating a debt in collections could potentially increase your score.

You Can Pay Off Debt Faster

Minimizing the interest you pay on your debt not only saves you money but also shortens your timeline for becoming debt-free (assuming you don't add debt elsewhere). The sooner you can eliminate your debt, the sooner you'll free up money for other important financial goals.

You Can Build Credit With On-Time Payments

Your payment history is the most influential factor in your credit score, and if you can qualify for more affordable payments, it can be easier to build a positive credit history with debt consolidation.

Even if you haven't been struggling to keep up with payments, paying your new loan or credit card on time can help bolster your credit history over time.

Learn more >> How Debt Consolidation Can Improve Your Credit

Drawbacks of Debt Consolidation

While there are some clear benefits to consolidating debt, there are also some potential downsides to consider before you move forward. Here are some cons of debt consolidation to keep in mind.

There May Be Upfront Fees

A lower interest rate won't always save you money in the long run. You may have to pay an upfront origination fee to take out a new loan, and many credit cards charge balance transfer fees.

These fees are generally a percentage of the amount you borrow, and the fee could be taken out of the funds you receive or added to your account's balance. Origination fees, for example, tend to be 1% to 6% of your total loan amount; balance transfer fees are often 3% to 5% of the amount you're transferring. You'll want to calculate how much the fee will be and compare it to your potential savings to see if debt consolidation makes financial sense.

You Might Not Qualify for a Favorable Offer

Your creditworthiness can affect your approval odds for a new loan or credit card, along with the loan amount, credit limit, interest rate and fees. If you have poor credit—for example, you have past-due accounts or debt in collections—you might not be able to get a debt consolidation loan or balance transfer credit card that offers significant savings opportunities.

If you're in this position, you still have options. In particular, you could look into debt consolidation via a debt management plan from a nonprofit credit counselor, which can help reduce your interest rates and monthly payments and bring past-due accounts current.

Freeing Up Available Credit Could Lead to More Debt

Consolidating your credit card debt is a good way to save money—as long as you won't be tempted to run up those balances again once the cards are paid off. If you do, you could end up in a worse situation than before you consolidated your debts.

If you tend to overspend, you can reduce the risk of using your cards again by removing them from your wallet and any online sites where you store your card numbers. Reducing access to your cards is usually better than closing your accounts, since that can have a negative effect on your credit scores.

Your Credit Could Suffer if You Miss Payments

In some instances, consolidating debt can increase your monthly payment instead of lower it. This is particularly true if you're currently paying just the minimum amount due on your credit cards.

If your new monthly payment is unaffordable, missing even a single one by 30 days can damage your credit score considerably.

Does Debt Consolidation Hurt Your Credit?

Debt consolidation can potentially impact your credit score negatively, but in most cases, the effects are temporary in nature. With that said, here's what you can expect:

• Hard inquiry: When you apply for a consolidation loan or balance transfer credit card, most lenders run a hard inquiry on one or more of your credit reports. A single inquiry typically takes fewer than five points off your credit score, but if you apply for multiple types of accounts in a short period, it could have a compounding effect.
• Payments: As previously mentioned, paying your bills on time is crucial for building and maintaining a good credit score. If you miss any payments during the consolidation process or after it's completed, your credit score could suffer.
• Credit utilization rate: Your credit utilization rate is the percentage of available credit you're using on a credit card. If using a balance transfer credit card to consolidate debt results in a high utilization rate on that card, it could hurt your credit until you pay down the balance. In the long run, however, paying off your debt more quickly should have an overall positive effect.
• Mix of accounts: Your credit mix is effectively how diverse your credit accounts are. If you pay off loans or close credit cards during the consolidation process, it could have a slight negative impact on your credit mix and, therefore, your credit score.

Should I Consolidate Debt?

Whether you should get a debt consolidation loan can depend on your mindset, motivation and credit offers:

• Mindset: If you've already started on your debt-payoff journey and are using debt consolidation as a tool to improve your financial standing, that may be a sign that consolidation will be helpful. But if you consistently struggled with debt due to overspending on discretionary expenses, think long and hard about whether consolidation could backfire rather than help.
• Motivation: If you're confident that you can stick to your debt repayment plan, which includes avoiding adding more debt while you work to pay off what you owe, consolidation can be a great fit. However, if you're uncertain about your ability to remain motivated and don't have plans to change your spending habits, consider working on those first.
• Credit offers: Even if you know consolidation is a good option, you still need to qualify for a new credit account that will actually help you. With Experian, you can get free access to your FICO^® Score^☉ and Experian credit report to see where you stand. Then, look for preapproved credit offers from lenders and credit card issuers to understand the terms and limits you can qualify for without a hard credit check.

Learn more >> Debt Consolidation Mistakes to Avoid

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How to Choose a Debt Consolidation Option

For the most part, the best options to consider include debt consolidation loans and balance transfer credit cards. Here's when you should consider one option over the other.

Here's how your monthly payment, total interest paid and time to pay off debt compares for different debt consolidation options. This assumes you have three credit cards with a total balance of $7,000 that you want to pay off. There is a 5% personal loan origination fee and 5% balance transfer fee.

From the example above, you can see that a balance transfer card with a 0% intro APR for 21 months saves you the most money. You won't pay any interest and will pay off your debt in less than two years.

How to Consolidate Debt

Once you've decided which debt consolidation option is the best for you, follow these steps to consolidate your debt.

Debt Consolidation Loan

1. Shop around. Take some time to research and compare debt consolidation loans to understand your options and loan terms. Many lenders offer prequalification, which allows you to get rate quotes without negatively impacting your credit score. In addition to interest rates, it's a good idea to compare origination fees, repayment terms and whether the lender offers to pay off your loans directly.
2. Submit an application. Once you find the right fit, you can typically submit an application online through the lender's website. You'll usually need to provide some basic information about yourself, including your name, Social Security number, date of birth, address, contact information, employment and income details and what you're looking for in terms of the loan amount and term.
3. Review the loan terms. Lenders may be able to underwrite and approve your loan application within minutes or even seconds after you submit it. If you're approved, carefully review the loan agreement to make sure the terms work in your favor. If you like what you see, you can typically sign the contract electronically.
4. Pay off your debt. If the lender you chose offers direct pay, you'll likely need to provide details about the debts you want to consolidate, including lender names and contact information and the payoff amount. If you opt to pay off the debt on your own, the lender will send the funds to your bank account, often within a few days but as soon as the same day. Once you receive the money, use it to pay off your accounts.

Balance Transfer Credit Card

1. Shop around. Look at and compare top balance transfer credit cards to get an idea of what each one offers. Pay special attention to the length of the 0% APR balance transfer promotion and the upfront balance transfer fee. Other features to consider may include a corresponding 0% APR promotion on purchases, welcome bonuses, rewards rates and other features that can add value long after the balance transfer promotion expires.
2. Submit an application. Once you've decided which card you want, submit an application through the credit card issuer's website. You'll provide some basic personal details, including your name, date of birth, Social Security number, address, contact information, employment and income information and housing costs. You may also be able to provide details about the cards you want to pay off directly in the application.
3. Submit your request. Credit card issuers can typically give you a decision on your application within seconds. If you're approved, the issuer will open the account automatically. If you didn't request a balance transfer in the application, you can do so after the account has been opened, either through your online account or by calling the number on the back of your card. Some issuers may even send balance transfer checks you can use to pay off your debts.

Debt Management Plan

You can consider a debt management plan if your options become limited and you can't qualify for a loan or balance transfer card. Professional credit counselors can help you on the path to paying off your debts by working with your creditors, making it easier to afford your monthly debt payments and assisting you with better financial management.

Learn more >> Is a Debt Management Plan Right for You?

Monitor Your Credit Score While Working to Pay Down Debt

Whether or not you choose to consolidate your debt, it's important to keep track of your credit score as you work to eliminate your debt. With Experian's free credit monitoring service, you'll get access to your FICO^® Score and Experian credit report, along with real-time alerts when changes are made to your credit report.

This invaluable tool can make it easier for you to understand how your efforts to become debt-free impact your credit and to address potential issues as they arise to minimize the damage they can cause.