Pros and Cons of Debt Consolidation

What Is Debt Consolidation?

Debt consolidation is the act of combining multiple debts into a single account. You can do this by taking out a new loan and using the funds to pay off your existing debts; personal loans are sometimes called debt consolidation loans when borrowers use the funds this way. It's similar to refinancing a loan, but you're refinancing several loans into one.

You can also apply for a balance transfer credit card and transfer balances onto the card to consolidate your debts. Or, you could use an existing credit line or credit card to consolidate debts.

Benefits of Debt Consolidation

Your current debts and your debt consolidation offers will greatly impact whether consolidation makes sense, but here are some of the main ways you might benefit from debt consolidation.

You'll Have Fewer Bills to Manage

Consolidation can make managing your household budget easier because every balance you pay off is one fewer account that you'll need to track and pay each month. Even if your balances, interest rates and monthly payments stay the same, freeing up your time and mental energy could be reason enough to look into debt consolidation.

You Can Free Up Money

Your accounts' interest rates and repayment terms determine your monthly payments, and you may be able to lower your overall monthly payments by combining multiple debts into one.

For example, if you take out a debt consolidation loan to pay off several credit cards, your loan's monthly payment may be lower than the credit cards' combined minimum payments. You can then decide whether you want to put the savings toward paying down your debt faster or for other expenses. And you have the flexibility to change your choice depending on your current needs.

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

Paying off your current debts with a lower-rate loan will lead to less interest accruing each month. You could also look into credit cards that offer introductory 0% annual percentage rate (APR) offers on balance transfers, letting you consolidate debt onto the card and pay off the balance without accruing any interest during the promotional period.

But a lower interest rate won't always save you money in the long run. Your overall costs will depend on whether you have to pay upfront origination or balance transfer fees and how long you take to repay the new debt.

You Can Bring Past-Due Accounts Current

You might be able to use debt consolidation to pay off accounts that are past due or in collections. Bringing the accounts current might help your credit score, but it can be difficult to do this with past-due accounts because you generally need to come up with enough money to pay off the entire balance. It can be hard to qualify for a new loan or credit card with past-due balances, but you could look into debt consolidation via a debt management plan from a nonprofit credit counselor.

Downsides of Debt Consolidation

Although debt consolidation can offer emotional and financial benefits, it's not always a good option. Beware of these potential drawbacks.

There May Be Upfront Origination or Balance Transfer Fees

You may have to pay upfront origination fees 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. 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.

Consolidating With a Secured Loan Can Put Your Assets at Risk

You can consolidate debts with various types of credit accounts, including secured loans like home equity loans and home equity lines of credit (HELOCs). Although it can be easier to qualify for a low interest rate with a secured loan, you risk losing the collateral you're using to secure the loan.

If you fall behind on unsecured credit card or loan payments, you might get charged fees and hurt your credit. Your creditors could even sue you and garnish your wages or bank account. That's certainly not good, but it's better than losing your home.

You Might Not Qualify for a Favorable Offer

Your creditworthiness can affect whether you'll qualify for a new loan or credit card and the loan amount, credit limit, interest rate and fees you receive. If you have poor credit, you might not be able to get a debt consolidation loan or balance transfer credit card that offers significant savings opportunities.

Freeing Up Available Credit Could Lead to More Debt

Using a new loan to pay off credit card balances doesn't address the root cause of why you wound up in debt. If you had a one-off expense or setback and are working to get back on your feet, that might be OK. However, if you tend to overspend with loans and credit cards (or seesaw between being debt-free and having large balances), then consolidation could be risky.

Moving your credit card balances will free up available credit, and you might be tempted to use the cards even more. Before you know it, you could wind up with a large debt consolidation loan and back in credit card debt.

Should I Get a Debt Consolidation Loan?

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

If you've already started on your debt-payoff journey and are using debt consolidation as a tactic or tool, 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.

Even if you know consolidation is a good option, you still need to qualify for a new credit account that will actually help you. Use a free credit check to get your credit report and score, as your credit can directly impact the offers you receive.

You can also look for preapproved credit offers from lenders and credit card issuers. These can help you understand the terms and limits you'll receive without a hard credit check—a review of your credit that could hurt your credit score temporarily. If you get preapproved for an offer that can save you money or lower your monthly payments, then it might make sense to proceed with an application.

Get Offers to See if Debt Consolidation Makes Sense

Going creditor-by-creditor to review your loan and credit card offers can take a lot of time— there are better ways to gather and compare offers. Use Experian CreditMatch™ to get debt consolidation loan offers from multiple providers with a soft credit check—the type that doesn't impact your credit scores. You can also compare balance transfer credit card offers to see if consolidating debts with balance transfers could be a good option.