Debt

What to Know About Debt Consolidation

Through April 20, 2022, Experian, TransUnion and Equifax will offer all U.S. consumers free weekly credit reports through AnnualCreditReport.com to help you protect your financial health during the sudden and unprecedented hardship caused by COVID-19.

Would it help to consolidate your debt? When your debt balances are high and you're managing monthly payments to multiple credit card companies, it's easy to feel overwhelmed. This is doubly true if your credit cards charge high interest rates that make paying off your debt seem like a distant dream. A debt consolidation loan could help simplify your bill paying, lower your interest rate and create a path toward eliminating debt. When it comes to debt consolidation, you should know that your loan choices are many and your critical shopping skills will come in handy.

What Is Debt Consolidation?

Debt consolidation is simply the act of combining several smaller debts into one. One way to accomplish this is by taking out a personal loan and using it to pay off your existing credit card balances. Debt consolidation loans are installment loans, meaning you'll pay the loan off in fixed monthly payments over a set period of time. Compared to the kind of revolving credit you have on a credit card, a debt consolidation loan typically offers a few key benefits:

  • Lower interest rates: Every situation is different, but debt consolidation loans tend to come with lower interest rates than credit cards typically do.
  • Lower monthly payments: Because the interest rates are lower, your monthly payments are likely to be lower as well.
  • Structured payoff: If you take out a debt consolidation loan, you agree to pay off your loan amount in a set period of time—say, three or five years. The good news here is that you'll be free of this debt when you're done paying the loan. By contrast, making minimum payments on your credit card could extend your payoff period to a decade or longer—more if you add to the debt as you go.

When Is Debt Consolidation a Good Option?

Lowering your interest rate and monthly payment probably sounds good. Add in the possibility of paying off your current debt entirely and a debt consolidation loan may seem like a solid win. But to get a lower rate and payment, you need to find—and qualify for—the right debt consolidation loan.

As usual, when it comes to borrowing, your credit score and history play a significant role: The best rates and terms are available to those with the highest credit scores. Though it never hurts to look into your options, exploring debt consolidation makes the most sense for you if you fit these criteria:

  • You have good credit. The objective here is to beat your current credit card interest rates. If your credit has taken a hit recently, you're less likely to come out ahead with a comparatively lower rate on your new loan. Check your credit score and report to find out where you stand.
  • Your current interest rates are high. If you're paying sky-high interest rates on your credit cards—and especially if your credit situation has improved significantly since you first applied for your cards—debt consolidation could be a wise move.
  • Your credit utilization is high. Credit utilization compares your credit card balances with your card limits. Calculate it by dividing the total dollars you owe on all your cards by the total of all your credit lines, and multiplying by 100 to get a percentage. A credit utilization of 30% or higher could be holding back your credit score.
  • You want to break out of the revolving debt cycle. Paying off your credit cards takes strategy and discipline. Though it's certainly not impossible, converting your revolving debt into a single loan can make it easier to tackle. Just be sure not to make your situation worse by using a debt consolidation loan to pay off your credit card balances only to rack up credit card debt all over again. Now you've doubled your debt, multiplied your monthly payments—and completely missed out on the benefits of debt consolidation.

How to Get a Debt Consolidation Loan

To begin your search, you need three things: Your credit score, your credit report and the amount of money you intend to borrow. Total up your credit card balances and download your credit report and score: You can access your credit report and score from all three credit reporting bureaus for free once a year on AnnualCreditReport.com, or get your Experian credit score and credit report any time directly from Experian.

An online search can help you find the best debt consolidation loan options for you. Is your credit less than stellar? You may still have options. Several online lenders offer debt consolidation loans for borrowers with fair—or even less-than-fair—credit. Whatever your credit status, varying interest rates and terms mean it's important to consider at least a few different loans to find the best fit. If you'd like to find multiple options in one place, You can use Experian CreditMatch™ to find loans based on your credit profile.

Once you've identified some possible lenders, examine your loan terms carefully. Since your goal is to lower your interest rate and monthly payment, make sure your new loan terms accomplish these objectives. A personal loan calculator can help you do this math. Also be aware of any application or origination fees that may be attached to your loan; these can drive up the overall costs of refinancing your debt.

How Do Debt Consolidation Loans Affect Your Credit?

On balance, getting a debt consolidation loan and paying it off on time may wind up improving your credit. Paying off your credit card balances with a new loan should reduce your credit utilization, which is an important factor in your credit scores. Also, the new loan adds to your credit mix, which can positively impact your score. In the long term, making your loan payments on time every month could have a lasting positive effect.

In the short term, however, hard inquiries on your credit report associated with the application, as well as the appearance of a new account, may lower your credit score temporarily. This effect is usually minor and not long-lasting, but it is something to be aware of. Adding a new account can also drop the average age of your credit accounts, which can affect your score as well.

Debt Consolidation Alternatives

What if a debt consolidation loan is not the remedy you were hoping for? Consider a few of these debt relief options, which don't require a loan approval or reshuffling your debt.

  • Set a budget and stick to it. Learn how to make a budget that accommodates all of your expenses, including debt payments, and use it to spend within your means.
  • Create a debt management plan. A certified credit counselor can work with you to negotiate with card companies and establish a manageable plan to pay off your debts.
  • Get help from friends and family. If you have friends or family who can lend you money to help cover debt payments while you sort out your obligations, you may be able to buy yourself a bit of breathing room.
  • Look for financial assistance. If you feel crushed by debt, financial assistance programs exist at the national, state and local levels that can help you cover other financial obligations and pay down your debt faster.

Making Debt Consolidation Work for You

A debt consolidation loan can help you save money and make it easier to pay off large credit card balances. By doing so, this kind of loan may also help you improve and maintain your credit scores and financial stability. Throughout the debt consolidation process, keep an eye on your credit score and report to make sure your credit card payoffs are correctly captured—and to watch your credit score improve as you pay down your consolidated debt.