What Is Debt Consolidation and How Does It Work?

Quick Answer

Debt consolidation involves paying off one or more existing debts with a new loan or credit card, preferably with a lower interest rate. With the right approach, debt consolidation can save you both time and money as you tackle your consumer debt.

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Debt consolidation is the process of paying off one or more debts with a new loan or credit card. If you're combining multiple debts into one, the process can simplify your debt repayment plan.

Additionally, you may be able to take advantage of a lower interest rate, a more favorable repayment plan and a shorter payoff timeline. Here's what you need to know about debt consolidation.

How Does Debt Consolidation Work?

Debt consolidation is primarily designed for borrowers with multiple debts, such as credit card balances, unsecured personal loans and medical bills. Using a new loan or credit card to pay off multiple balances allows you to combine all of your monthly payments into one.

However, it's also possible to consolidate a single loan or credit card balance. While there are several different ways you can consolidate debt, the two most popular options are a balance transfer credit card and a debt consolidation loan.

Find the best balance transfer credit cards with Experian.

Balance Transfer Credit Card

A balance transfer credit card is a type of credit card that offers an introductory 0% annual percentage rate (APR) promotion, which could last up to 21 months. During this time, you can pay down debt transferred from another credit card—some even allow you to consolidate certain types of loans—without paying any interest. Some of the best balance transfer credit cards also offer welcome bonuses, rewards and other perks.

That said, balance transfer credit cards typically charge an upfront fee of 3% to 5% of the transfer amount. You may also have a deadline by which you need to request the transfer to qualify for the 0% intro APR promotion. Finally, you won't find out what your new card's credit limit is until you're approved. Depending on how much debt you have, it may not be sufficient to cover your full balance.

Before you apply for a balance transfer credit card, check to see if any of your existing cards offers a 0% intro APR promotion on balance transfers—preferably one that doesn't already have a balance.

Debt Consolidation Loan

A debt consolidation loan is a personal loan you can use to pay off credit cards, medical bills and other types of debt. Personal loans don't offer a 0% APR promotion, but if you have good or excellent credit, you may be able to get approved for a lower interest rate than what you're currently paying—especially if you're trying to consolidate credit card debt.

Additionally, personal loans offer a fixed repayment schedule, which can range from one to seven years in most cases. This feature can be particularly beneficial for people with credit card debt who struggle to stick to a payment plan.

Some personal loan companies charge an upfront origination fee, which can range from 1% to 12% of the loan amount. However, you may be able to avoid an origination fee if you have good or excellent credit.

Debt Consolidation vs. Debt Settlement

Debt settlement is another way to tackle an unwieldy debt burden, but it's not the same as debt consolidation, and it comes with several risks. With debt settlement, you negotiate with your creditors to pay less than what you owe. You can try doing it yourself, or you can hire a debt settlement company to do it for a fee.

However, because your payment history is the most important factor in your credit score, settling your debt for less than what you owe can have major negative consequences for your credit score. On top of that, debt settlement companies typically have you stop making payments on your debts while saving up for the settlement amount, which can cause your credit scores to plummet even further.

In contrast, debt consolidation can have an impact on your credit score when you apply and open a new loan or credit card. But as long as you make your payments on time, there likely won't be any long-term damage. In fact, if it helps you avoid late payments and you pay the loan as agreed, debt consolidation can even help your credit.

What Credit Score Do You Need for Debt Consolidation?

Balance transfer credit cards typically require you to have good credit or better to get approved. A good FICO® Score starts at 670, but credit card issuers may have their own minimum score requirements. They'll also consider other factors, such as your credit history, income and other debt.

As for personal loans, there are options available to borrowers across the credit spectrum. If you have fair or poor credit, however, you may have a hard time qualifying for an interest rate that's low enough to help you save money. Personal loans for bad credit are also more likely to charge costly origination fees.

So, while it's not technically required to have good credit to get a consolidation loan, it'll give you a better chance of getting the terms you need to make it worth your while.

Does Debt Consolidation Hurt Your Credit?

Consolidating your debt can cause a slight temporary decrease in your credit score. This is largely due to the hard inquiry the lender makes when you apply for credit and the new credit account, which reduces your average age of accounts.

If you get a balance transfer credit card, your credit could also dip if the transfer results in a high credit utilization rate on your new card. As you pay down the balance, however, your credit score will likely improve.

If you use a consolidation loan to pay off credit card debt, your utilization rate won't be a factor since credit scoring models only consider utilization of revolving credit (such as credit cards). In fact, reducing your utilization rate on your credit cards to 0% can potentially help your credit score.

Pros and Cons of Debt Consolidation

As you consider whether debt consolidation is right for you, it's important to weigh both the benefits and drawbacks. Here are some to keep in mind.


  • Interest savings: Whether you pick a balance transfer credit card or a personal loan with a lower interest rate than the one you're currently paying, you could potentially save hundreds of dollars on interest charges.
  • Repayment flexibility: With a balance transfer card, you could get a 0% intro APR promotion for anywhere between 12 and 21 months. But if you have a lot of debt and need more flexibility with your monthly payment, you could opt for a debt consolidation loan and get more options, making it easier to find a term that works for you.
  • Easier to manage: If you have multiple monthly payments throughout the month, consolidating your debts combines all of them into one payment, making it easier to manage your repayment plan.


  • You may not qualify: If you don't have good or excellent credit, you may have a hard time getting approved for a balance transfer card or a low-interest debt consolidation loan. Even if your score is in good shape, you may not get the terms you're looking for if you have a significant amount of debt.
  • There may be upfront fees: You'll be hard-pressed to find a balance transfer credit card that doesn't charge a balance transfer fee on a 0% APR promotion. While you can get a personal loan with no origination fee, your options may be limited if your credit isn't near perfect. While these fees aren't necessarily a deal-breaker, don't forget to include them when calculating your potential savings.
  • It could lead to more debt: While consolidating your debt can put you in a better position to pay down your debt, it doesn't change the circumstances that put you in debt in the first place. Unless you have a clear plan for avoiding more debt, freeing up available credit on a credit card with another card or a personal loan could put you in danger of racking up another balance.

Should You Consolidate Your Debt?

As you weigh the advantages and disadvantages of debt consolidation, think carefully about how they apply to your situation and goals.

In particular, debt consolidation can be beneficial if you have good or excellent credit and have enough debt that you stand to save at least a few hundred dollars in interest.

If you're thinking about a balance transfer card, consider it only if you can afford to pay off your debt within the promotional period and you have enough discipline to stick to your repayment plan. If you're considering a personal loan, make sure you can afford the monthly payment—while extending your loan term can reduce your payment amount, it could neutralize your interest savings.

Finally, consider debt consolidation if you have a plan to avoid adding more debt. This may be easy if your debt is largely due to circumstances outside of your control. But if it's a result of overspending, you may need to make some significant changes to your budget and spending to avoid making matters worse.

Review Your Credit Before Applying for Debt Consolidation

In many cases, you can get prequalified for a personal loan or a credit card. But to make sure you have all the information you need to evaluate your options, check your credit score and credit report for free with Experian.

In addition to knowing where you stand, you'll also be able to pinpoint areas of your credit profile that need some work and make some improvements before you start the consolidation process.