How Does Debt Consolidation Work and Is It Right for You?

Between credit cards, auto loans, personal loans, and other debts, you might be juggling multiple payments to multiple lenders.

Trying to keep track of different repayment schedules, balances, and interest rates can get difficult — and it's far too easy to miss a payment.

Consolidating your debt is one way to stay on top of your debt repayment and get your finances back on track. Here’s how it works and what you need to know.

What Is Debt Consolidation? 

Debt consolidation is a way of tackling multiple payments on multiple debts.

The debt doesn’t disappear, but by combining several debts into a new loan (preferably at a lower interest rate), you could pay off your debts faster.

You can consolidate debt with lenders that specialize in debt consolidation loans or DIY it with a generalized personal loan from any other bank or financial institution.

Either way, you'll take out a new loan that incorporates all of your current debts.

What about debt relief or debt management plans?

There are also third-party organizations that can help you pay off your debt, but be cautious about which one you choose.

Nonprofit credit counselors are a safe bet — they often offer debt management plans (DMPs), where the counselor helps you set up a repayment plan. While DMPs typically come with a small fee, they could help you get your finances back in order.

However, there are also for-profit debt relief companies that try to reduce how much you owe. Be wary. They often charge high fees that could add to your debt. And part of their negotiation tactic is for you to stop paying your creditors altogether, which will tank your credit score.

Debt relief or debt settlement is not the same as debt consolidation.

READ MORE: Is Debt Settlement a Good Idea?

Pros and Cons of Debt Consolidation

Before consolidating your debts, make sure this type of loan benefits you. The compelling reasons for debt consolidation don’t apply to everyone.

Pro: Have a single monthly payment

Managing different debts with varying interest rates, balances, and due dates can be a hassle that leaves you more susceptible to missed or late payments. A consolidation loan streamlines your debts into one monthly payment. 

Pro: Potentially pay off debt faster

Debt consolidation loans can result in a higher monthly payment than the minimums on each account. Plus, if you qualify for a lower interest rate, a greater percentage of every payment will go toward the principal instead of interest. 

Pro: Lower interest rate

Qualifying for a lower interest rate is one of the primary appeals of debt consolidation. If a lender can offer you a lower APR on a consolidation loan, that increases the impact of each monthly payment on the balance.

Con: Larger monthly payments

Your monthly payment may go up. Run through your budget to determine how realistic the new loan payment will be. You don’t want to roll your debts into a new loan and then find yourself unable to afford the monthly payments. 

Con: Debt consolidation fees

Lenders may charge an origination fee or a prepayment fee. If you have a large amount of debt, the fees may be worth it. But for a smaller debt, any potential savings on interest might not balance out the cost of a new loan. 

Con: It can’t change spending behavior

Consolidating debts won't instantly stop you from making new charges on your accounts. Be careful of debt consolidation as a magic button to fix an underlying cash flow or money management problem.

Con: You could pay more in interest

If you have poor credit, you may not qualify for a lower interest rate. Some people might consolidate debts anyway to get a lower monthly payment, and while this makes the payments more manageable, it could also mean paying more in interest because you’ll be in debt longer. 

READ MORE: How To Increase Your Credit Score the Right Way

Is a Debt Consolidation Loan Right for You?

Look at your debts and run through this checklist to determine if a debt consolidation loan is best for you:

• Has your credit score improved? That makes you more likely to qualify for a lower interest rate. 
• Is it difficult to keep track of multiple debts and creditors? A single monthly payment can simplify debt repayment. 
• Is your total debt balance fairly large? The benefits of consolidation are more likely to be worthwhile in that case.
• Are you confident in your ability to avoid adding more debt? You want to make sure you don't end up right back where you started.

If the answer to each of these questions is “yes,” then you’re probably a good candidate for a debt consolidation loan. 

RELATED: How To Pay Off Credit Card Debt

What To Look for in a Debt Consolidation Loan

When you're shopping around for a debt consolidation loan, the key factor to consider is a lower interest rate. Aside from the convenience of switching to one payment, the rate is what can save you money in the long run.  

You’ll also need to be aware of any fees charged by the lender. Find out how much of your debt can be consolidated and what terms are required. 

Calculate how a new loan will impact your finances and decide what will help you reach your goals in a timely way. Seek quotes from several lenders to be sure you’re getting the best offer. 

FAQs

TL;DR: Should You Consolidate Your Debts?

Debt consolidation can simplify your life with one monthly payment instead of having to juggle several — especially if you can get a lower interest rate. But you need to have your spending under control and make sure the new loan terms actually save you money.

Before consolidating, check your credit score to see if you qualify for better rates, calculate the total cost including any fees, and get quotes from multiple lenders.

Most importantly, commit to not racking up new debt. If you can't confidently control your spending habits, debt consolidation might just be putting a band-aid on a bigger problem that needs addressing first.