Is Debt Consolidation a Good Idea?

Is consolidating debt a good idea? For many people, it can be, but the approach does have risks to consider, too. Below, we’ll walk you through the ins and outs of debt consolidation, including the most popular ways it’s done, its benefits and drawbacks, and even some alternatives for those who decide it’s not the right move right now.

What Is Debt Consolidation?

Debt consolidation is an approach where you use one new debt product, often a debt consolidation loan, to pay off all of your existing debts. Then, you’ll have only one single monthly payment to worry about — potentially with a lower interest rate.

Along with taking out a personal loan for this purpose, you can also consider doing a credit card balance transfer, using a new credit card with a 0% interest promotional period. However, this approach to debt consolidation requires serious discipline and planning. That’s because if you take longer than the promotional period to pay back the balance, you’ll be stuck with the normal interest rate (which is often, for credit cards, in the double digits).

When Is Debt Consolidation a Good Idea?

Debt consolidation can be a good choice for those who have a lot of smaller debts they’re working on paying off and a strong enough credit score to qualify for a personal loan that would cover all of them. (Personal loans, because they aren’t secured by collateral, tend to have stricter eligibility requirements than other loan types, so keep in mind that this approach usually requires some solid financial markers, including a good credit score and demonstrable income.)

Debt consolidation might not be a good idea, on the other hand, if you know you’re going to have to take out more debt in the near future, which could foil your overall debt repayment strategy. It’s best for those who are committed to changing their spending habits for the long haul and getting debt-free, rather than those who are looking for a short-term fix. Ideally, you’ll be confident at the outset of a debt consolidation process that you’ll be able to make the new loan’s monthly payments consistently for the entire repayment period.

Recommended: Consolidating Debt as a Married Couple

Benefits of Debt Consolidation

Here are some of the unique benefits of debt consolidation.

Lower Interest Rate

Most debt consolidation loans are personal loans. These often have higher interest rates than, say, mortgages or auto loans, but they often have lower rates than commercial credit cards (which is where many people rack up their debt). If you pay off, say, several credit cards and the final part of your student loan with a debt consolidation loan, you’re likely to end up paying less interest overall, even if one of the loans you’re paying off technically had a lower interest rate.

Single Monthly Payment

For many people, this is the most attractive feature of a debt consolidation loan: It streamlines the process of managing debts. It’s easy to get behind or miss payments if you’re keeping track of seven different accounts each month. With a debt consolidation loan, you’ll be responsible for only a single monthly debt payment.

Help for Your Credit Score

Because a large part (30%) of your credit score is calculated based on the amounts you owe, a debt consolidation loan could improve your score when you pay off high-balance debt products like maxed-out credit cards.

Additionally, since you’ll be making only that one monthly payment, as discussed, it can be a lot easier to make on-time payments each month. Since payment history counts for 35% of your score, that can be a big boost, too.

Reduced Stress

Let’s be real: Anything that can make our lives less stressful in this world is often worthwhile. And many people who take out debt consolidation loans say the loans do just that. Making a single monthly payment is simply, well, simple — no more accidentally missed bills and late notifications.

Risks and Drawbacks to Consider

Now that you know the benefits, you may be asking yourself, “Is a debt consolidation loan a good idea for me, personally?” The truth is, as useful as this strategy can be, there are also risks and drawbacks to keep in mind, such as:

•   Not qualifying. Many people who are struggling with debt also have less-than-perfect credit histories, which can make it more difficult to qualify for the personal loan or balance-transfer credit card you need to consolidate your debt.

•   High interest rates. Again, because these loans can have tougher eligibility requirements, those without perfect credit may see higher interest rates. A debt consolidation loan calculator can help you understand the overall cost of your decision.

•   Falling deeper into debt. This is a big (but preventable!) one. Some people feel a surge of relief when they see their credit card balances reduced to zero. They may then feel like it’s not such a big deal to treat themselves a little bit. But if you spend your credit cards back up, you’ll soon find yourself with multiple credit card debts and a debt consolidation loan to pay back. And that means you have an even bigger debt problem than you started with.

Recommended: Understanding Direct Consolidation Loans

Alternatives to Debt Consolidation

If debt consolidation isn’t the right answer for you right now, there are still other options to consider.

Debt Settlement

Debt settlement involves negotiating with your creditors to, as its name suggests, settle your debts. You’ll come to an agreement wherein they’ll let you off the hook for less than you owe overall.

Many people contract with debt settlement companies to help them with this project, sometimes also known as debt relief or debt adjustment services. However, it’s important to understand that these companies are not nonprofits, and they sometimes charge large fees to help you navigate the negotiation process. Additionally, there can be ramifications to your credit report if the company tells you to stop paying your bills as it goes through the negotiations.

Choosing a nonprofit consumer credit counseling service can be a better bet for those hoping to negotiate their debts with professional help while also avoiding expensive fees. You can also reach out to your creditors to negotiate directly, but this may not be as effective as it would with assistance.

Bankruptcy

Filing for bankruptcy will release you from most of your debts, but it comes with long-lasting credit ramifications. The bankruptcy will remain on your credit report for up to 10 years, which can severely lower your credit score. Still, it’s sometimes the right option for those whose debts prove insurmountable.

Credit Counseling

As mentioned above, credit counseling services are more often nonprofit organizations and are set up to help consumers navigate their debts with confidence. You can search for approved credit counseling services by state and jurisdiction through the U.S. Department of Justice.

DIY Debt Snowball and Avalanche Methods

Finally, you can also tackle your debts the old-fashioned way — by simply chipping away at them on your own. Two of the most popular tactics are both wintry metaphors: the snowball method and the avalanche method.

For both approaches, you’ll start by listing your debts, along with your balance total and interest rate. For the snowball method, you’d start with the lowest-balance debt first, and put all the extra money you can each month toward paying that one off, and then move up the list from there (while, of course, making minimum payments on all your accounts). For the avalanche method, you’d do the same, but start instead with the highest-interest loan, and move down by interest rate.

The snowball method can help keep people motivated by giving them a real feeling of progress sooner, while the avalanche method can help you save money on interest overall.

The Takeaway

Is a debt consolidation loan a good idea? For many people the answer is yes. Debt consolidation can be a very useful strategy for those who qualify, but it requires some planning and discipline to do properly. It helps if you have a good credit score, but even if you don’t, you may be able to save money on interest by consolidating debt. And a debt consolidation loan can also help simplify the debt payment process and lower your stress level.

Credit cards have an average APR of 20%–25%, and your balance can sit for years with almost no principal reduction. Personal loan interest rates average 12%, with a guaranteed payoff date in 2 to 7 years. If you’re carrying a balance of $5,000 or more on a high-interest credit card, consider a SoFi Personal Loan instead. See your rate in minutes.

SoFi’s Personal Loan is cheaper, safer, and more predictable than credit cards.

FAQ

Will debt consolidation hurt my credit?

Debt consolidation can temporarily hurt your credit because of the hard credit inquiry that will be required to take out a new loan. However, these credit dings are usually just a few points, and usually fall off relatively quickly. Overall, many people find that debt consolidation helps their credit in the long term.

Is it better to consolidate debt or pay off separately?

It’s really up to you. Both are valid ways to manage and pay down debt, but many find debt consolidation, which leads to one monthly payment, an easier and less-stressful strategy overall.

What is the best way to consolidate debt?

There are two main ways to consolidate debt: with a debt consolidation loan (or personal loan) or by using a credit card balance transfer. Both are useful, but a debt consolidation loan is more flexible for different types of debt. Additionally, balance transfers are often impacted by increasing interest rates over time. You’ll have to race to pay off the transferred balance before interest rates rise in order for this method to be cost-efficient.

How long does debt consolidation stay on your credit report?

If you take out a new loan for debt consolidation, it can stay on your report for up to 10 years after it’s paid off, just like any other loan. If you use a credit card balance transfer, the card will stay on your report in perpetuity until you close it — and then, again, for up to 10 years after.

Can I still use credit cards after consolidating?

While you can still use your credit cards after consolidating your debt, it’s best to approach that move with caution. Running up your credit cards after using a loan to pay them off can continue the debt spiral you were attempting to get out of in the first place — and with the additional loan, your new debt problem can become even bigger.

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Photo credit: iStock/Liudmila Chernetska

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